DEMAND FOR

MONEY
Dr. RAJASHRI DEHPANDE
ASSISTANT PROFESSOR
MULUND COLLEGE OF COMMERCE
 MEANING
• Demand for money occupies a significant place in macro economics.
• It arises due to functions performed by money.
• Medium of exchange & Store of value
 Classical approach to demand for money
• Developed by David Hume, J. S. Mill and Irving Fisher
• Transaction approach is considered as money works as a medium of
exchange.

• M= Money supply, V = Velocity of circulation, P= Price & T = Total

volume of transactions.
 Assumptions to equation
• Full employment of resources exists in the economy.
• Variables ‘V’ & ‘T’ are assumed to be constant.
• The changes in ‘M’ do not affect V & T.
• Velocity of circulation of money is an independent factor.
• Velocity of circulation of money remains constant in the short run.
• The quantity of money ‘M’ is fixed by the central bank.
 criticisms
• T refers to all transactions of goods & services, shares & securities, etc.
the value of capital assets is highly fluctuating in nature, hence it is
unrealistic.
• There can not be a general price level which can cover both transactions.
 Highlights of classical approach
• Demand for money arises due to the medium of exchange function of
money.
• Money is demanded mainly for transaction purposes.
• Demand for money depends upon the volume of transactions, velocity of
circulation of money & price level.
 NEO-CLASSICAL APPROACH
• Developed by Cambridge economists Alfred Marshall & A.C. Pigou
• Based on store of value function of money.
• Known as Cash- Balance approach
• Demand for money implies the desire of the people to hold cash balance.
• It is a fraction of annual income, which people want to keep in the form of
cash balances.
 NEO-CLASSICAL APPROACH

• K=Proportionate of nominal
income people desire to hold.
• P= Price level
• Y= Real National Income
 NEO-CLASSICAL APPROACH
• Cambridge school of economists considered income as the main factor
influencing demand for money. Income elasticity of demand for money
and Price elasticity of demand were assumed to be unitary.
• Other factors like rate of interest, wealth, expectations about future price
are not considered.
• Cambridge approach is considered important for establishing the relation
between demand for money & level of income.
 KEYNESIAN APPROACH

Transaction Precautionary Speculative

• Level of • Unforeseen • Rate of
Income emergency interest
• Price level • Future • Secure gain
contingencie
s
 KEYNESIAN APPROACH

Active Cash Balance Idle Cash Balance

• Level of income • Store of value function
• Time interval • Speculate- quick profits
• Price level • Interest elastic
• Spending habits • Fluctuations in market
• Choice & preferences
 KEYNESIAN APPROACH
Active Cash
Balance Idle Cash Balance
KEYNESIAN APPROACH
 LIQUIDITY PREFERNCE THEORY OF INTEREST

• Transaction
• Income
• Income interval
• Regularity of income
• Precautionary- Emergency
• Unseen contingencies
• Working capital
• Speculative –Idle-Rate of Int
 Liquidity Preference
• MN is Money Supply
• LP is Liquidity Preference
• Active Cash balance = Consumption-Production-Investment- Income=C + S
• Rate of Interest – Mr. A wants to earn 20,000/ per month- Idle Cash bal
• 12%- 20,00,000 = 2,40,000
• 10% - 24,00,000 = 2,40,000 = 4 Lakhs
• 8% - 30,00,000= 2,40,000 = 6 Lakhs
 Limitations /Criticisms
• Interest is a reward for productivity but not for parting with liquidity.
• Keynes ignored productivity time preference.
• Depression- Low rate of interest / Inflation- High rate of Interest.
• Vague & Contractionary.
• Not applicable to indeterminate level of income.
• Narrow approach as other factors are not considered.
THANK YOU