Income Level and Transactional Motive of Money Demand

Transactional Motive of Money Demand

Money demand is a measure of the quantity of money, usually expressed as a percentage of GDP, people wish to hold to carry out transactions. It is an important concept in macroeconomics as it has implications for the level of interest rates and inflation in an economy. One of the factors that influence money demand is the transactional motive, which refers to the need for money to carry out everyday transactions. In this article, we will explore the relationship between income level and the transactional motive of money demand.

Income Level and Transactional Motive

Income level is a crucial determinant of the transactional motive of money demand. The higher the income, the more transactions a person can carry out. This is because a higher income means that a person has more resources to spend, leading to a higher demand for money to facilitate those transactions.

For example, a person on a low income may only have enough money to buy the essentials, such as food and shelter. They therefore do not need to hold large amounts of money to carry out transactions. In contrast, a high-income individual may have sufficient resources for a range of transactions, including luxury goods and services. As a result, they require a larger amount of money to facilitate those transactions, leading to a higher demand for money.

Income Effect on Money Demand

The income effect on money demand can be explained using the Keynesian cross model. This model suggests that income and the quantity of money demanded are positively correlated. In other words, as income increases, so does the demand for money to carry out transactions.

This relationship can be demonstrated using the following equation:

$$M_d = kY + \beta$$

Where:

• $$M_d$$ is the demand for money
• $$Y$$ is income
• $$k$$ is the income effect
• $$\beta$$ is the autonomous effect

The income effect, $$k$$, represents the change in money demand for each unit change in income. The autonomous effect, $$\beta$$, represents the change in money demand that is not influenced by income.

Conclusion

In conclusion, the transactional motive of money demand is influenced by income level. The higher the income, the greater the need for money to carry out transactions. This relationship can be explained using the Keynesian cross model, which suggests that income and the demand for money are positively correlated. Understanding the relationship between income and the transactional motive of money demand is essential for policymakers and economists as it has implications for setting interest rates and managing inflation in an economy.