For example, households need money to buy groceries and firms need money to pay for materials and labor.
STUDY. So income is generally used as a surrogate for wealth. Each factor's impact on demand is unique.
This is the analogue of the prices of a commodity and its substitutes and complements in the theory of consumer demand. These people are then more likely to purchase sooner, which would increase demand for the product. It may be noted that money is not demanded for its own sake but because it can be used to purchase economic goods and services. Keynes, however, had considered only bonds as the competing non-money asset. The identification of a stable relationship between the demand for money and its determinants provides empirical evidence that monetary targeting is an appropriate framework for economic stabilization policy (Rutayisire [as cited in Bhatta, 2013, p.1). Speculative motive. Likewise, if P increases people will require more money to buy the same amount of goods and services. Constancy of national income implies fixed demand for money for transactions and precautionary purposes.
Therefore, Friedman introduces the ratio of non-human to human wealth (w) as a variable in the demand function.The nominal rate of return on money may be zero as on currency, or positive as on saving deposits or even negative if current account deposits are subject to net service charges. Monetary equilibrium occurs when the demand for money equals the supply of money. This results in the demand curve shifting from D1 to D2. The determinants of demand are factors that cause fluctuations in the economic demand for a product or a service. Originally, the consumption function was said to have a nega-tive second derivative. It may be noted that money is not demanded for its own sake but because it can be used to purchase economic goods and services. But those held for the speculative purposes are particularly sensitive to it. First, individuals will demand money to finance their daily purchases of goods and services. For example, if meditation classes became more expensive, then there would be an increase in demand for yoga classes.If the size of the market increases, like if a country’s population increases or there is an increase in the number of people in a certain age group, then the demand for products would increase. Here, L is liquidity preference (or speculative demand) which is a function of the rate of interest (r) L varies inversely with r. vanes inversely with r. An individual’s preference for liquidity, money, therefore arises because of his uncertainty about the exact point in time when he will need money – the precautionary motive -and his uncertainty about future interest rates – the speculative motive. where Md is the total demand for money, kPY is transactions and precautionary demand and L(r) is speculative demand. Money kept as a store of wealth comes within this category. Keynes argued that there are three motives for holding money. Total wealth, 2. This figure illustrates the mechanics of transactions demand. Obviously, for them the expected rate of change of prices (adjusted for storage costs) gives the appropriate rate of return, and this becomes especially important under conditions of inflation or deflation: Besides the above, there may be other variables that affect the utility attached to the services of money relative to those rendered by other assets, and so should be included in the demand function for money. Thus, we see that the rate of interest rises when there is excess demand for money and falls when there is an excess supply of money. The demand for money comes from the desire to hold liquid assets of which money is the only perfect example. All the articles you read in this site are contributed by users like you, with a single vision to liberate knowledge.Before publishing your Article on this site, please read the following pages:PreserveArticles.com is a free service that lets you to preserve your original articles for eternity.
Liquid balances are required to be kept in hand to provide for emergencies like sickness or accident. The way in which these factors affect money demand is usually explained in terms of the three motives for demanding money: the transactions, the precautionary, and the speculative motives. The demand for money is affected by several factors, including the level of income, interest rates, and inflation as well as uncertainty about the future.
They also must keep some money in hand for their day-to-day transactions. The expected rates of return on money and other assets and 4. As such the standard theory of demand for consumer goods can be applied to the demand for money.
Secondly, people will demand money as a contingency against unforeseen expenditures. Total wealth, 2. Transactions demand and precautionary demand vary directly with the first two factors but speculative demand for money vary inversely with the market rate of interest. In fact, the rate of interest does the job of equating the quantity of money demanded to the available supply, i.e., it does the job of producing monetary equilibrium.
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