Support the Monkey! Tell All your Friends and Teachers

Help / FAQ

(C) Demand for Money: The demand for money is made in the form of currency or cash possessed or in the form of checkable and quickly withdrawable saving deposits. All such demands are mainly meant for carrying out a variety of activities. There are household demands for purchasing several consumption goods, for payment of services of doctors, teachers, for purchasing durable goods like property or automobiles etc. A firm or a trader demands money for purchasing raw materials or plant and machinery, for the payment of wages, salaries and other factor payments etc. Besides such a demand for money in order to carry out various transactions, some people demand it for hoarding or holding wealth in liquid form. It can conveniently be used according to variations in the market conditions. Each of these purposes is called motive for demanding money. There are three chief motives for which money is demanded. These are transactions, precaution and speculation. The first two motives are traditional and classical economists made use of them. The third motive of speculation is modern; Keynes has introduced and analyzed this particular motive.

i) Transactions Motive: Money is demanded to perform variety of regular economic transactions. Both households and firms have to carry out a variety of transactions for which they need money. Even an individual member going out to school, college or the workplace has to spend on transport, buying beverages, snacks etc. for which he needs some money. Throughout the day millions of transactions are taking place for which money is paid or received.

The demand for money on account of the transactions motive is fairly stable. It is related to the size of the income and type of activities performed by individuals, households and firms. Since the size of the income does not change suddenly and significantly, the demand for money for this purpose is normally constant in the short run. Demand for money to satisfy transactions motive is about 50 percent of the size of an individual or household income.

ii) Precautionary motive: Money demanded to satisfy the precautionary motive is for meant for unforeseen circumstances. This amount of money kept aside can be used during times of uncertainty or emergency. An individual or a household creates such demand to face future possibility of accident, sickness, unemployment, old age, education of the children etc. The firms, corporate bodies and governmental agencies also demand money to meet the precautionary motive. Fluctuating economic conditions, future uncertainties, sudden needs of expenditure, failure of expectations are some of the examples which necessitate such demand for money. Even this type of demand for money is more or less steady in its amount. It depends mainly on the size and responsibilities of the family and size of the income. In the short run these factors remain constant and hence demand for money also remains nearly constant.

iii) Speculative motive: Keynes was the first economist to admit the role of speculative activities in modern economy and that of demand for money made by speculators. Such demand is made to invest in capital market for buying shares, bonds, securities etc. when their prices are low. But speculators quickly dispose of their securities when their prices are sufficiently high. They make capital gains from such transactions. In order to carry out this activity, speculators create demand for money on a large scale. Keeping money in this idle form is known as hoarding of money. Keynes has shown that speculative demand for money is highly fluctuating. It all depends upon fluctuating prices and market conditions for securities. Therefore total demand for money or liquidity can be classified into two parts:

Total demand for money = L = L1 + L2

L1 is that part of money or liquidity demanded to satisfy transactions and precautionary motives. This is more or less stable in size. Keynes calls this the demand for Active Cash balances or money. The second part L2 is money demanded made to satisfy the speculative motive. Such demand for money is highly unstable and fluctuating. Keynes has called this as demand for Passive Cash balances or money. Speculative demand depends upon the prices of securities but these prices are highly sensitive to the rate of interest. Therefore small variations in the rate of interest or even expected changes in the rate or interest can create large variations in speculative demand for money.

(D) Supply of Money: Supply of money is carried out and regulated by a monetary authority. Generally such a monetary agency is in the form of a central bank (Federal Reserve Bank, Bank of England, Reserve Bank of India etc.) and the Finance Minister or such other government agency. The supply of money is institutional and part of a policy decision. It does not depend upon the economic behavior of individuals of firms. Therefore the supply of money remains stable in the short run.

In a modern economy besides official currency there is a variety of other resources which act as near money and perform similar functions as medium of exchange. Some of them are convertible into currency after a lapse of time and with some inconvenience. These include checkable deposits, current deposits, savings and fixed deposits, very long-term deposits with postal or insurance agencies, certificate deposits etc. All these forms of money make up for the total supply of money. With the inclusion of some or more varieties of these kinds of money the total supply can be classified into four categories. These are as follows:

M1 = Total currency, coins and notes, checkable or current            deposits
M2 = M1 + Saving and fixed (time) deposits
M3 = M2 + Insurance company and postal bank deposits
M4 = M3 + very long-term deposits, certificate deposits etc.

According to the context of this discussion, supply of money can be stated in terms of one or the other category. When monetary authority directly attempts to alter money supply or quantity then it is of M1 the type. But generally, money supply is of the M3 type.


6.1 Money
6.2 Banking

Chapter 7

All Contents Copyright © All rights reserved.
Further Distribution Is Strictly Prohibited.

In Association with