Demand and Supply of Money

Money is a necessity for daily life, and from an economic perspective, it is an asset. The public wants to own it; hence, there is a demand for money. From person to person, it varies based on the reason for holding money and the time period. Here is a detailed explanation of the demand for money and the supply of money. Read more about the impact of changes in the money market in this article.

Define Demand for Money

The desire of people to hold liquid financial assets is reflected in the demand for money in the market. There are several motives based on which the demand for money is dependent. The following motives from the Keynesian theory of employment reflect why people demand money and how it impacts their lives.

Transaction motive - for daily needs, people tend to hold money to buy products and services. Basically, buying something and paying money contributes to the demand for money, which is positively related to the real GDP (income).

Precautionary motive - to prevent and protect themselves, people often hold money to safeguard themselves from crises, emergencies, and unforeseen circumstances. 

Speculative motive - the future is completely unpredictable, hence money is significantly important for people. They hold money to know how the future is, and accordingly invest in assets or stop investing based on the risks.

Define Supply of Money 

The supply of money is determined as the total quantity of monetary assets at a specific time in the economy. Different factors influence the concept of money supply; therefore, below are the factors that influence cash flow, integrate assets and liabilities:

Nature - The Central bank sets the supply of money, which is mostly considered on a graph as a vertical line. Basically, the bank money supply never changes with the interest rate.

Determination - By using the monetary policy actions, the money growth is determined by the central bank in open market operations.

The Money Market & Equilibrium

The equilibrium is established based on the interaction between the quantity of money and the interest rate. It is when the interest rate at a specific quantity of money is similar to the quantity of money.

Impact of Changes

The demand and supply for money explain the desire for a specific amount of money so that they can buy products and services. Money is necessary in managing transactions, especially in business correspondence. Henceforth, the quantity of money is determined by income, bank transactions, and the money supply. Below are the two types of money supply.

Increased Money Supply

At the initial interest rate, the central bank establishes a surplus of money, which again leads to decreasing the interest rates, thus encouraging investment and borrowing. 

Decreased Money Supply

To define money supply, we can say that the interest rates keep rising when there is a reduction in the money supply. With the increasing interest rate, the money supply also decreases; thus, there is a potential for inflation to slow economic growth. This often leads to a global financial crisis, impacting the overall economy.

Concluding: Money Demand and Supply

When concluding the demand and supply of money, it must be said that there are various motives influencing them. In economics, demand for money means the existing stock of money, instead of a constant flow of cash over time. Furthermore, the supply of money is determined by policies established by the banking system of credit control.

Read More

• Unit Trust of India
• Monopoly Market
• Capital Market
• Marginal Cost
• Total Cost
• Theory of Cost

Frequently Asked Questions (FAQs)

What factors affect the demand for money?

The factors that influence the demand for money are inflation, interest rates, economic uncertainty, and income level.

What is the role of the Reserve Bank of India in money supply?

RBI plays an important role in money supply using tools like bank rates, reserve requirements, and open market operations.

What is the speculative motive for holding money?

When an individual holds money, the speculative motive is to wonder about future changes in asset prices or interest rates.

How does monetary policy affect money supply?

The expansionary monetary policies increase the money supply; however, there are contractionary policies degrade the growth.

How is the demand for money affected by interest rates?

The demand for money decreases as interest rates increase. This happens with speculative demand when people prefer to invest in high-yielding assets. However, people hold more money when the rates are low.