DEMAND OF MONEY

Demand of Money

The demand for money is merely the sum of individual demand for money to

hold.

Human demand money for the following reasons:

To fulfill their basic needs

To do business

To make value transaction

To develop their life style

To create further money

To do investment purpose

Demand for Money – Classical View

• The classical view is that money is not demanded for its own sake,

because it has no direct utility for its holder. Money is demanded because

it has purchasing power. As per the classical view money has no value

itself, it becomes valuable when it is used for the medium of exchange.

Demand for Money – Keynesian Approach

• But money consider as the store of values as per the Keynesian view.

According to Keynesian beside the medium of exchange, money is used

for the store of value. Keynesian emphasized on the saving sector of

money rather than current consumptions.

The Motives of Holding Money

• Definition: The Motives for Holding Cash is simple, the cash inflows and

outflows are not well synchronized i.e. sometimes the cash inflows are

more than the cash outflows while at other times the cash outflows could

be more. Hence, the cash is held by the firms to meet the certain as well

as uncertain situations.
The motives of Holding Money

Transaction Motive:
• The transaction motive refers to the cash required by a firm to meet the

day to day needs of its business operations. In an ordinary course of

business, the firm requires cash to make the payments in the form of

salaries, wages, interests, dividends, goods purchased, etc.

• Likewise, it also receives cash from its sales, debtors, investments. Often

the firm’s cash inflows and outflows do not match and hence, the cash is

held up to meet its routine commitments.

The Motives of Holding Money
 Precautionary Motive:

 The Precautionary motive refers to the tendency of a firm to hold cash, to

meet the contingencies or unforeseen circumstances arising in the course

of business.

 Since the future is uncertain, a firm may have to face contingencies such

as an increase in the price of raw materials, labor strike, lockouts, change

in the demand, etc. Thus, in order to meet with these uncertainties, the

cash is held by the firms to have an uninterrupted business operation.

The Motives of Holding Money
 Speculative Motive:

 The firms hold cash for the speculative purposes to avail the benefit.

 Thus, a firm holds cash to exploit the possible opportunities that are out

of the normal course of business. These opportunities could be in the

form of the low-interest rate charged on the borrowed funds, expected

fall in the raw material prices or favorable change in the government

policies.
The Motives of Holding Money

 V = R/r

 Where V is the current market value of a bond, R is the annual return on the bond,

and r is the rate of return currently earned or the market rate of the interest.

 So a bond worth Rs. 100 (V) and carrying a 4 percent rate of interest (r), gets an

annual return (R) of Rs. 4, that is,

 V=Rs 4/0.04=Rs.100.

 When the market rate of interest rises to 8 percent, then V=________

 When it fall to 2 percent, then V= _________

The Motives of Holding Money
Liquidity Trap

 Liquidity Trap is a situation when expansionary monetary policy (increase in

money supply) does not increase the interest rate, income and hence does

not stimulate economic growth.

FACTORS AFFECTING THE DEMAND FOR MONEY

1. Interest Rates: Money and bonds are substitutes, as money is used to

purchase bonds and bonds are redeemed for money. The two differ in a few

key ways. Money generally pays very little interest, but it can be used to

purchase goods and services. Bonds do pay interest, but cannot be used to

make purchases. If bonds paid the same interest rate as money, nobody

would purchases bonds as they are less convenient than money. Since

bonds pay interest, people will use some of their money to purchase bonds.

The higher the interest rate, the more attractive bonds become.
FACTORS AFFECTING THE DEMAND FOR MONEY

2. Consumer Spending: This is directly related to factor: “Demand for Goods

Goes Up”. During periods of higher consumer spending, such as the month

before Christmas, people often cash in other forms of wealth like stocks and

bonds, and exchange them for money. They want money in order to

purchase goods and services, like Christmas presents. So if the demand for

consumer spending increases, so will the demand for money.

FACTORS AFFECTING THE DEMAND FOR MONEY

3. Precautionary Motives: If people think that they will suddenly need to buy

things in the immediate future, they will sell bonds and stocks and hold

onto money, so the demand for money will go up. If people think that

there will be an opportunity to purchase an asset in the immediate future

at at a very low cost, they will also prefer to hold money.

FACTORS AFFECTING THE DEMAND FOR MONEY

4. Change in the General Level of Prices: If we have inflation, goods become

more expensive, so the demand for money rises. Interestingly enough, the

level of money holdings, tends to rise at the same rate as prices. So while

the nominal demand for money rises, the real demand stays precisely the

same.
FACTORS AFFECTING THE DEMAND FOR MONEY

5. International Factors: Following factors can cause the demand for the

currency to rise:

• An increase in the demand of that country’s goods abroad.

• An increase in the demand for domestic investment by foreigners.

• The belief that the value of the currency will rise in the future.

• A central banking wanting to increase its holdings of that currency.

Factors Which Increase the Demand for Money

• A reduction in the interest rate.

• A rise in the demand for consumer spending.

• A rise in uncertainty about the future and future opportunities.

• A rise in transaction costs to buy and sell stocks and bonds.

• A rise in inflation causes a rise in the nominal money demand but real money

demand stays constant.

• A rise in the demand for a country’s goods abroad.

• A rise in the demand for domestic investment by foreigners.

• A rise in the belief of the future value of the currency.

• A rise in the demand for a currency by central banks (both domestic and foreign).