Money Demand Theory

Study Notes

The theory of money demand explains the factors that influence the demand for money and how it affects the economy.

Key Assumptions

Money is held for transactions and precautionary motives
People hold money to facilitate transactions and as a precaution against unexpected expenses

Determinants of Money Demand

Interest Rate: As interest rates rise, the opportunity cost of holding money increases, reducing money demand
Income: As income increases, people hold more money for transactions and precautionary motives
Price Level: As prices rise, people need more money to maintain their purchasing power
Wealth: Increase in wealth leads to an increase in money demand for precautionary motives
Inflation Expectations: Expected inflation reduces money demand as people expect prices to rise

Theories of Money Demand

People hold money for speculative motives, expecting interest rates to rise
Liquidity preference schedule shows the inverse relationship between interest rate and money demand

Money demand is a function of permanent income, interest rate, and the price level
The demand for money is a stable function of these variables

Money is considered an asset, and people allocate their wealth between money and other assets
The demand for money depends on the expected returns on alternative assets and the risk associated with them

The theory of money demand explains the factors that influence the demand for money and its effects on the economy.
Money is held for two main purposes: transactions and precautionary motives.

Interest Rate: A rise in interest rates increases the opportunity cost of holding money, leading to a decrease in money demand.
Income: An increase in income leads to an increase in money demand for transactions and precautionary motives.
Price Level: As prices rise, people need more money to maintain their purchasing power, increasing money demand.
Wealth: An increase in wealth leads to an increase in money demand for precautionary motives.
Inflation Expectations: Expected inflation reduces money demand as people expect prices to rise.

People hold money for speculative motives, expecting interest rates to rise.
The liquidity preference schedule shows the inverse relationship between interest rate and money demand.

Money demand is a function of permanent income, interest rate, and the price level.
The demand for money is a stable function of these variables.

Money is considered an asset, and people allocate their wealth between money and other assets.
The demand for money depends on the expected returns on alternative assets and the risk associated with them.