Supply and Demand for Money

In an economy, the concept of supply and demand is always prevalent in different

aspects. For instance, money; it is an integral part in the functions of an economy and is widely
used as a medium of exchange for commodities and services. Money is also used daily by
individuals, businesses, governments and the like for many purposes. This may be used for
essentials and necessities, for business operations, for financial support, and more. Hence, it is
clearly demanded by what comprises the entirety of an economy. With that, questions such as:
where does money come from, how does money circulate in an economy, and who utilizes this
money, often arise regarding such topics. In this paper, it will tackle the topics of money supply,
money creation, and money multiplier, which will answer these questions and give an overview
of how the supply and demand for money functions in an economy. It will also deal with the
concept of economic indicators, as it is also related on how it influences the supply and demand
for money.
To begin with, the supply for money is created and given by central banks, which is then
distributed to other commercial banks who provides services of loans and deposits for
individuals and entities in an economy. The demand for money can be categorized into three:
transaction demand, money needed for purchasing goods; precautionary demand, money needed
for unexpected financial emergencies; and asset motive/speculative demand, money used for
purchasing assets and investments. With that, there is the process of money creation. For
instance, the government’s spending comes from taxes, however, this can also be financed in
another way such as a bond. A bond is promise to pay a certain amount of money, including
interest, after a certain period which then constitutes a debt obligation. The government secures a
bond from the central bank in order to meet the costs for the society. The money circulating in
this process is what drives the economy. Moreover, money creation is regulated by central banks,
as they are also who decides the level of money creation in an economy. It is also a leading
process for the increase in money supply.
In relation to money generating from central banks, it is also involved with the concept of
money supply This entails that the total stock of money circulating in an economy is measured
by the money supply. It includes stock of notes or other money equivalents that can be easily
converted to cash which is referred to as narrow money or M0. While there is also broad money
or M4 which is comprised of notes, plus coins, plus deposits in bank accounts, and other liquid
assets. With this, money supply is a basis on how money circulates in the economy, as it
measures the total supply or stock of money at a given point in time. Money supply is also
controlled by central banks; this is because they dictate the interest rates, the printing of new
money, and the like, which in turn can either increase or decrease the money supply. Moreover,
individuals, or entities such as businesses or corporations either go to banks for a loan, or to
deposit money for their savings. Hence, when these individuals and entities deposit their money
in banks, the banks then use a fraction of this money as a reserve for those who apply for loans.
This is referred to as fractional reserve banking, which is commonly discussed under the money
multiplier.
In continuance from the topic firstly mentioned, money multiplier is simply one (1)
divided by the reserve ratio. This means that in each dollar/peso the banks generate, there is an
increase in additional money to circulate in the economy. Furthermore, banks also often use the
fractional reserve banking, which is a system that states a fraction of bank deposits are reserved
by actual cash on hand and is also available for withdrawal. This entails that banks cannot lend
one’s entire deposit, but only a fraction of it, as the rest are reserved. In money multiplier, it
plays a large part of in money creation. This is because a greater portion of money is carried out
by commercial banks that provide credit, or loans from individuals to businesses. When a loan is
granted, the bank uses its collected deposits from its customers to finance this credit with added
interest. This forms the supply and demand for money in an economy.
In addition to these topics, there are also economic indicators that influences the supply
and demand for money. Firstly, the primary economic indicator which is the Gross Domestic
Product (GDP), shows the overall performance of an economy. It consists of, consumption,
investment, government expenditure, and net exports. The relation of GDP to the supply for
money is important since is shows the impact such. For example, when the GDP shows an
increase in economic productivity, the value of money in circulation rises. Another economic
indicator is inflation. This is because it presents a significant effect on an economy, as well as its
effect on money supply. When central banks decide to produce more money, there will be an
increase in the money supply, which will cause inflation. Hence, when there is inflation, the
demand for money will also be affected depending on the money circulating the economy.
In conclusion, money is used in the day to day lives of individuals and entities in an
economy. This is either through loans, and incomes which then can be turned into deposits
primarily for banks. There is always a demand for money, and the central bank is the main
supplier for such. It controls the interest rates, the money circulating the economy, and
ultimately, the people who utilizes it, such as individuals, businesses, and governments.
Furthermore, there are also the concepts of money creation, money supply, and money multiplier
which aids in the understanding of supply and demand for money. Economic indicators, such as
GDP and inflation are linked in the supply and demand for money, as it indicates the impact and
influence on the overall economy.