Demand for Money

Dr. M Manjunath Shettigar

The demand for money
Two different concepts of demand for money:

Medium of exchange concept of the demand for

money-CLASSICAL VIEW

Store of value concept of the demand for money-

MODERN VIEW
 CLASSICAL VIEW
Money is not demanded for its own sake
Demand arises on account of exchange transactions,
from the demand for goods and services
Depends upon the supply of exchangeable goods and
services available in the market which is not constant
So is demand for money which varies from time to time
and determined exclusively by objective factors such
as volume of exchange transactions

Equation of Exchange is MV=PT

M=total quantity of money, V=velocity of circulation
P=price level, T= total amount of goods and services
exchanged for money
 Velocity of circulation of money
A unit of money may be spent several times during
given period of time

Average number of times money is transferred from

one person to another in a given period of time is
known as velocity of circulation of money

Hence total supply of money in a given period is

total amount of money in circulation multiplied by its
velocity of circulation
Factors affecting velocity
i. Quantity of money
ii. Frequency of cash transactions
iii. Credit facilities
iv. System of wage payment
v. Regularity or irregularity of income
vi. Size of propensity to consume
vii. Distribution of income
viii. Peoples liquidity preference
ix. Business conditions
x. Stage of economic development
xi. Future estimates of prices
xii. Mobility of credit money
MODERN VIEW also known as Keynes view
Demand for money means the demand to hold
money or cash balances

Also known as liquidity preference which is the

demand for liquidity or cash, desire to hold
assets in cash

Money is not merely to be spent but held as a

form of wealth

It serves as an excellent store of value

 Motives behind liquidity preference
Transaction motive/demand
is the need of cash for the current transactions of
personal and business exchange
Further split as
i) business motive : to bridge the interval between the time of incurring business
costs and receipt of sale proceeds- transaction motives of businessmen,
industrialists, traders, merchants, etc. who require certain amount of money in
order to carry on their day-to-day business
ii) income motive: to bridge the interval between the receipt of income and its
disbursement- transaction motive of the consumers who require cash
balances to make day-to-day purchases of goods and services for
consumption
Transaction demand for money is directly proportional and
positive function of the level of income.
Depends on two things: i)on the business turnover ii) on
the timing and size of personal incomes
 Precautionary motive/demand
Desire to provide for contingencies requiring sudden
expenditure and for unforeseen opportunities of
advantageous purchases
Both individuals and businessmen keep cash in
reserve to meet unexpected needs
Represents the store of value function of money
Depends on uncertainty of future
Depends upon:
level of income
business activity
opportunities for unexpected profitable deals
availability of cash
cost of holding liquid assets
Speculative motive/demand
A liquid store of value which can be invested at
an opportune moment in interest bearing bonds
and securities
Objective is for speculative purposes with a view
to earn income
Uncertainty of future rate of interest causes
demand for money for the speculative motive
A decreasing function of rate of interest higher
the rate, lower the demand for money and lower
the interest, higher the demand for money
Is highly volatile depending upon the behaviour
of interest rates
Total demand for money
According to Keynes,
Transaction motive and precautionary motive is
primarily a function of level of income, while the
speculative demand is the function of rate of
interest
Thus total demand for money is a function of
both income and interest rates.