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Demand for money

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The Major reason for the people’s demand for money is that it is needed in any economy in which almost every person and firm sells goods and services for money and in turn uses money to buy the goods and services offered by others. Functionally this amount of money used as a medium of exchange. Classical theory explained the demand for money as essentially a demand resulting from this need for money as medium of exchange.

In Keynesian theory, money becomes much more than a medium of exchange, much more than a medium of exchange, much more than a device for meeting transactions in the marketplace. People also demand money for speculative purposes and as security against unforeseen needs for cash reserves. The break down of the demand for money into transactions and precautionary and speculative demands plays a vital part in the theory of Keynes.

The Major reason for the people’s demand for money is that it is needed in any economy in which almost every person and firm sells goods and services for money and in turn uses money to buy the goods and services offered by others. Functionally this amount of money used as a medium of exchange. Classical theory explained the demand for money as essentially a demand resulting from this need for money as medium of exchange.

In Keynesian theory, money becomes much more than a medium of exchange, much more than a medium of exchange, much more than a device for meeting transactions in the marketplace. People also demand money for speculative purposes and as security against unforeseen needs for cash reserves. The break down of the demand for money into transactions and precautionary and speculative demands plays a vital part in the theory of Keynes.

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Demand for money

  1. 1. Demand for Money Dr.M.MADHAVAN
  2. 2. INTRODUCTION • The Major reason for the people’s demand for money is that it is needed in any economy in which almost every person and firm sells goods and services for money and in turn uses money to buy the goods and services offered by others. • Functionally this amount of money used as a medium of exchange. • Classical theory explained the demand for money as essentially a demand resulting from this need for money as medium of exchange.
  3. 3. • In Keynesian theory, money becomes much more than a medium of exchange, much more than a medium of exchange, much more than a device for meeting transactions in the marketplace. • People also demand money for speculative purposes and as security against unforeseen needs for cash reserves. • The break down of the demand for money into transactions and precautionary and speculative demands plays a vital part in the theory of Keynes.
  4. 4. TYPES OF DEMAND FOR MONEY •Transaction Demand •Precautionary Demand •Speculative Demand
  5. 5. Transaction Demand • Every one needs to hold some amount of money to carry out ordinary day- to-day transactions. If the amount that a person received at each point in time equaled the amount that he or she paid out at each point in time, no money balance at all would be required for transactions. In practice of course no person or firm even approaches this limiting case, despite the ability of each to exercise some control over the timing of receipts and payments. Everyone must, therefore, hold some amount of money to cover the unevenness between the timing of what comes in and what goes out.
  6. 6. Transaction Demand … … …. • No two persons have identical time patterns of payments, and few find their total payments for any month evenly distributed over the month. Particular days include above average payments: • The day the mortgage payment or rent is due the day the car payment must made, the day for payment of all or part of the balance on department store charge accounts, Master Card, Visa, and so on. • However, as a first approximation, let us assume that there is an even distribution of payments over the month. What we want to see is that, with this pattern of payments, a person whose receipts for the month all come in on the first day of the month. • This requires a larger average money balance over the month. In this case the same total receipts came in at regular intervals during the month. • As a general rule, the average money balance of a person or firm must hold over time for transaction declines as the frequency of receipts rises.
  7. 7. Transaction Demand … … …. • For example, assume an individual has receipts of Rs. 1400 per month and he makes payments of an equal amount each month for convenience, assume that each month has exactly four weeks. • The monthly receipts of Rs. 1400 may arrive in a number of different time patterns. Such as Rs. 1400 on the first day of the month, Rs. 700 on the First and Fifteenth day of the month, or Rs. 350 on the First day of each week (an amount of Rs. 2800 bimonthly would also technically qualified). • If this individual actually receives the Rs. 1400 on the first day of the month disburses the full amount evenly over the month, he will have a money balance of Rs. 1400 at the beginning of the first week, Rs. 1050 at the beginning of the second week, Rs. 700 at the beginning of the third week and Rs. 350 at the beginning of the fourth week. • His balance shrinks to the zero at the end of the fourth week, but then jumps back again to Rs. 1400 the next day. His average money balance for the month in the case is Rs. 700 an amount equal to half of his monthly receipts. • His actual money balance at each point during the month is as shown by the curve in the following figure..
  8. 8. Transaction Demand … … …. • Suppose now that this individual receives the same monthly receipts at a rate of Rs. 350 per week paid to him on the first day of each week. • Assuming as before that his payments equal his total receipts, his money balance at the beginning of the first day of the week will be Rs. 350, at the beginning of the second day Rs. 300 and so on with an average money balance of Rs. 175 for the week - an amount equal to one-half of his weekly receipts. • In this case, his actual money balance at each point during each week is shown in part B of the above FIGURE. • In which one fourth of the same income is received at the beginning of each of the month’s four weeks (4 x Rs. 350 instead of 1 x Rs. 1400).
  9. 9. Transaction Demand … … …. • It means a fourfold rise in the frequency of receipts and a reduction in this person’s average money balance to one fourth (Rs.175 instead of Rs. 700) of what it would be in the monthly case. • If we extend the illustration to the case in which the case in which the monthly receipts of Rs. 1400 arrive at Rs. 50 per day , we would find that these sevenfold increase in the frequency of receipts (7 x Rs. 50 instead of 1 x Rs. 350) would be accompanied by a reduction in this person’s average money balance to one-seventh (Rs. 25 instead of Rs 175 ) of what it would be in the weekly case.
  10. 10. Transaction Demand … … …. • In summary, over time the amount of money needed to handle transactions will tend to shrink to the extent that some persons and firms achieve a closer degree of synchronization (relationship) between receipts and payments. • Over time the amount of money needed, will tend to increase to the extent that the Rupee volume of transactions to be mediated increases. • The Rupee volume of transactions has, of course, doubled and redoubled over the long run. What ever the strength of the forces working in the other direction may have been, the rising volume of transactions has many times outweighed it to give us an almost uninterrupted increase year after year in the amount of money balances that all persons and firms combined find it necessary to hold in order to mediate the total volume of transactions.
  11. 11. Precautionary Demand • Transaction demand for money stems largely from a lack of synchronization between receipts and expenditures; similarly, precautionary demand arises primarily because of the uncertainty of future receipts and expenditures. Precautionary balances enable persons to meet unanticipated increases in expenditures of unanticipated delays in receipts. • This type demand for money varies to some extent with one’s income. Individuals need more money and are better able to set aside levels. The precautionary demand also varies inversely with the interest rate. Unlike a transactions balance (something definitely scheduled for use in the near future), a precautionary balance secures one against a “rainy day” that may never come. At a high enough interest rate, one smaller precautionary balance in exchange for the high interest rate that can be earned by converting part of this balance into interest - bearing assets. • Although precautionary demand may be formally distinguished from transactions demand, the total amount of money held to meet both demands is viewed primarily as a function of the level of income and, to some extent, of the interest rate. As in the case of the transaction demand, we will assume, for the sake of simplicity, that precautionary demand is interest inelastic and that it too depends solely on the level of income.
  12. 12. Speculative Demand • The proposition that money is held for transactions and a precautionary purpose does not conflict with the classical view. • A transactions balance is nothing more than money in its function as a medium of exchange. • A precautionary balance is nothing more than money in its function as medium of exchange. • A precautionary balance can be added to the classical system without materially affecting its conclusions. • But this is as far as the classical theory of rent. The speculative demand for money, a systematic part of the demand for money in Keynesian theory, represents a distinct break with classical theory.
  13. 13. Speculative Demand … …. ….. • Classical theory assumed that a person would hold no money in excess of the amount needed to meet his transactions (including precautionary) requirements. • To do otherwise would put that money into a bond. Classical Economists reasoned that, even if the interest rate were very low, it should be better to get some return than none at all. • Keynes, however, pointed out that one who buys a bond is “speculating” that the interest rate will not rise appreciably during the period in which he intends to hold the bond. • If he believes that it will rise, he would be wise to hold noninterest-bearing money. • This uncertainty as to the future interest rate causes people to hold money for speculative purposes. • If the future interest rate were known with certainty, there would be no speculative demand for money, and there could be no objection to the classical concept of the demand for money.
  14. 14. manimadhavan@gmail.com 9865210146

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