Money Demand and Money Supply
Demand for Money: Liquidity preference of a particular individual depends upon several considerations. The question is: Why should the people hold their resources liquid or in the form of ready money when they can get interest by lending money or buying bonds (a store value of money)? The desire for liquidity arises because of three motives: (i) The transaction motive;
(ii) The precautionary motive;
(iii) The speculative motive.
The Transaction Motive for money (Tr): Individuals hold money or cash balances for transaction purposes because receipt of money do not coincide with payments. Generally, people receive their incomes monthly while the expenditure goes on day by day. The businessmen and the entrepreneurs also have to keep a proportion of their resources in money form in order to meet daily needs of various kinds. So, in general demand for money arises because individuals have to incur expenditure on goods and services. Demand for money carries a direct relationship with the level of income. Demand for money balances is treated as a demand for real cash balances rather that nominal balances, where Real cash= Nominal CashPrice level. ∴Tr=TrY
The Precautionary Motive for Money (Pr): Precautionary motive for holding money refers to the desire of the people to hold real cash balances for unemployment, sickness, accidents and other uncertain perils. The amount of money demanded for this motive also carries a direct relationship with the level of real income. ∴Pr=PrY
The Speculative Motive for Money (Sp): This motive for money is to take advantage of market movements (generally asset market) regarding the future changes in the rate of interest (or bond prices) The cash held under this motive is used to make speculative gains by dealing in bonds whose prices fluctuate. [If bond prices are expected to rise which, in other words, means that the rate of interest is expected to fall, businessmen will buy...