Cambridge O Level Economics: Money, banking and household spending, saving and borrowing (2281) – Revision Notes

These notes condense sections 3.1.1, 3.1.2 and 3.2.1 of the Cambridge O Level Economics 2281 syllabus for examination in 2026 (topic 3, Microeconomic decision makers). The syllabus is not tiered. Full explanations are in the study guide. Test yourself with the practice set, check coverage on the printable checklist and find the course on the hub. The wider topic notes are in the Microeconomic decision makers revision notes. For a quick check of your level, try the free 10-minute diagnostics.

Every figure below is invented for illustration.

3.1.1 Money

Definition to learn: money is anything generally accepted as payment for goods and services and in settlement of debts.

Barter problem: needs a double coincidence of wants; no common measure; goods may not divide or keep.

Forms	Notes
Commodity money	Valued for own use (salt, cattle). Hard to divide and carry
Coins and notes	Issued by the state or central bank; accepted through trust and law
Bank deposits	Balances moved by card, transfer or cheque
Electronic and mobile money	New way of moving bank balances

Function	One-line test
Medium of exchange	Do sellers accept it as payment?
Unit of account	Are prices and wages quoted in it?
Store of value	Will it buy about the same later?
Standard of deferred payment	Can debts be agreed now and settled later?

Characteristics: acceptable, durable, portable, divisible, uniform, limited in supply, stable in value. To judge an item, pick the two or three that matter most and say how it scores on each.

Method: is it good money?

1. Name the item and the use it is being put to.
2. Test it against the characteristics, giving one reason each way.
3. Reach a verdict.

Worked reminders (invented).

• Barter with 5 goods needs 5 × 4 ÷ 2 = 10 exchange rates; with 50 goods, 50 × 49 ÷ 2 = 1,225. Money needs one price per good.
• Prices up from index 100 to 125: money buys 100 ÷ 125 = 80 per cent as much, a 20 per cent fall in purchasing power (not 25).
• A loan of 800 repaid after a year at 5 per cent: 800 × 1.05 = 840. Debt contracts use money as the standard of deferred payment.

3.1.2 Banking

	Central bank	Commercial bank
Owner and aim	Usually a public body, serves the national interest	Private firm, aims at profit
Customers	Government and banks	Households and firms
Main roles	Issues notes and coins; banker to government and banks; lender of last resort; monetary policy; supervision; reserves	Deposits; loans, mortgages, overdrafts; payments; currency exchange; advice

Importance, in one line each.

• Government: central bank manages its accounts and borrowing and carries out its policy; commercial banks lend to it and move tax payments.
• Producers: loans and overdrafts to invest and cover gaps; payment services; stable money makes planning easier.
• Consumers: safe savings; loans and mortgages; payments; a trusted currency and a supported banking system.

How a bank earns (invented). Deposits 1,000,000; 80 per cent lent = 800,000. Interest in at 9 per cent = 72,000. Interest out at 3 per cent = 30,000. Gross margin 42,000, before running costs. Banks charge borrowers more than they pay savers; they also keep some funds back for withdrawals.

Chain of reasoning for a bank-lending question.

1. Banks lend, so firms invest and households buy.
2. This raises spending and output.
3. But heavy lending to borrowers who cannot repay leads to losses and a cut in lending.
4. So supervision and a lender of last resort matter. Judge by how strong the banks and borrowers are in the situation given.

3.2.1 Spending, saving and borrowing

Key terms. Disposable income = income after tax. Saving = disposable income − spending. Saving ratio = saving ÷ disposable income × 100.

Influence	Higher	Lower
Income	More spending, more saving in amount; usually a larger share saved	Less of both; more borrowing to cover essentials
Rate of interest	Saving rewarded, borrowing costs more, so less borrowing and spending	Saving less attractive, borrowing cheaper, so more borrowing and spending
Confidence	More spending and borrowing, less precautionary saving	Less spending, more saving, debt avoided

Between households: income level, dependants, wealth, existing debts, attitude to risk, age, access to credit.

Over time: stage of life, changes in income, interest rate changes, confidence, expected prices.

Formulas and worked reminders (invented).

• Saving ratio: income 3,000, spending 2,550, saving 450; 450 ÷ 3,000 = 15 per cent.
• Income 2,000 to 2,400 is up 20 per cent; spending 1,700 to 1,980 is up 16.5 per cent; saving 300 to 420 is up 40 per cent. Saving ratio 15 to 17.5 per cent.
• Simple interest: 3,000 at 3 per cent for 2 years: 3,000 × 0.03 × 2 = 180. Compound: 3,000 × 1.03² = 3,182.70, interest 182.70.
• Real return (approximate): nominal rate minus inflation. 3 − 4 = −1 per cent: savings lose purchasing power.
• Flat-rate loan: repayment = amount + amount × rate × years; instalment = repayment ÷ months. 12,000 at 10 per cent for 2 years: 12,000 + 2,400 = 14,400; 14,400 ÷ 24 = 600 a month.
• Overdraft cost: 250 at 18 per cent for a year is 250 × 0.18 = 45.
• Confidence shock: non-essential spending of 1,500 falls 8 per cent: 1,500 × 0.92 = 1,380, so 120 is saved.

Evaluation reminders. A rate cut raises spending only if households borrow; weak confidence, heavy debts or tight lending weaken the effect. Higher income raises spending only if it is expected to last. Saving can be a reward for patience and also a cost to firms that need demand.

Must-know distinctions

Pair	Difference
Money and income	Money is what is used to pay; income is what you earn over a period
Money and wealth	Wealth includes houses and shares, which are not generally accepted as payment
Central and commercial bank	Public body that serves government and banks; private firms that serve the public
Saving and savings	Saving is a flow in a period; savings are the stock built up
Nominal and real interest	Real adjusts for inflation
Simple and compound interest	Compound pays interest on earlier interest

Quick self-test

1. Name the four functions of money.
2. Why does barter need a double coincidence of wants?
3. State two characteristics of good money and explain one.
4. Prices rise by 60 per cent (index 100 to 160). What fraction of its original purchasing power does money keep, as a per cent?
5. Give two roles that only a central bank usually performs.
6. How do commercial banks help producers?
7. A household earns 2,500, spends 2,125. Find the saving ratio.
8. Find the interest after 2 years on 4,000 at 3 per cent a year, simple and compound.
9. Interest 6 per cent, inflation 2 per cent. Approximate real rate?
10. Explain why low confidence may cut spending even when income is unchanged.
11. Give two reasons two households on the same income might save differently.
12. Why might a cut in interest rates fail to raise household spending?

Answers

1. Medium of exchange, unit of account, store of value, standard of deferred payment.
2. A seller must want what the buyer offers at the same moment; otherwise no swap happens.
3. For example durable and divisible. Divisible: it can pay for small and large items and give change.
4. 100 ÷ 160 × 100 = 62.5 per cent, a loss of 37.5 per cent.
5. Any two of: issues notes and coins, lender of last resort, banker to commercial banks, carries out monetary policy.
6. Loans, overdrafts, payment services and accounts for wages and suppliers.
7. Saving = 375; 375 ÷ 2,500 × 100 = 15 per cent.
8. Simple: 4,000 × 0.03 × 2 = 240. Compound: 4,000 × 1.03² = 4,243.60, so interest 243.60.
9. About 4 per cent (exactly about 3.92).
10. Households fear future income loss, so they delay purchases and keep a precaution fund.
11. Any two of: different numbers of dependants, existing debts, age, attitude to risk, expected future income.
12. Low confidence, heavy existing debt, lenders refusing credit, or a worry about future income.

Where marks are usually lost

• Calling cash the only form of money and leaving out bank deposits.
• Naming a function but not explaining or illustrating it.
• Writing “banks give out loans” with no link to producers, consumers or government.
• Mixing up the central bank and a commercial bank.
• Giving income as the only influence on saving and ignoring confidence and interest.
• Failing to compare two households or two time periods when the question asks for it.
• Dropping working in a calculation, or giving 25 per cent where the loss of purchasing power is 20 per cent.
• Ending an evaluation point with “it depends” and no stated reason.

The assessment overview says calculators may be used in both papers, so use one, but still write the working.

Official syllabus

Cambridge O Level Economics 2281, syllabus for examination in 2026, version 2, published by Cambridge University Press and Assessment (Cambridge International). Sections 3.1.1, 3.1.2 and 3.2.1.