Demand for Money and supply

of money
 Functions of money
• Unit of value
• Medium of exchange
• Money as standard of deferred payments
• Store of value
 Money

• Money supply
• M1 = CP + DD + OD
• M2 = M1 + Post office saving account deposit.
• M3 = M1 + time deposits of banks
• M4 = M3 + total deposits of post office
Parameters which decides supply of money

• Deposit multiplier: capacity to create credit by

the banking system.
• Money multiplier is M/ HM. Money multiplier
is influenced by RBI and banking network.
 Demand for money
• Demand for real balances depends upon

- level of real income

- interest rates
 Demand for money
• Quantity theory of money-” Fisher”
MV = PY
• Cambridge equation- ‘Marshal’
demand for real money is a function of real
income.
• Modern theory of demand for money – ‘M. Friedman.
demand for money is nothing but application of
demand for capital.
M/P = f ( W, r, w, T )
 Demand for money - Friedman
• The rate of return on bonds
• The rate of return on equities
• The rate of change in prices
• The ratio of non human wealth to human
wealth
• Real income
• Tastes and preferences
 Demand for money
• The demand for money is the demand for real
balances.
• The demand for money depends on the level
of real income and the interest rate.
 Liquidity preference theory of Keynes.

• There are three motives for demand for

money.
a) Transaction motive
b) precautionary motive
c) speculative motive
 Liquidity trap
• Liquidity trap is that situation where increase
in money supply will not change bond price
and hence interest rate.
• People will prefer cash over bond.
• Money supply has no impact on rate of
interest , income and employment.
• Monetary policy becomes ineffective.
Criticisms of liquidity preference theory

• Short term theory

• Keynes ignores the influence of real factors
• Keynes assume that liquidity preference is
purely a monetary phenomenon
• In the Keynesian analysis an individual can
hold either money or bond but not both.