What is Demand for Money?

If you are an economics student, then you must learn about the demand for money and its influence on governments, businesses, and individuals. It holds a certain portion of the wealth in various forms of money, be it cash, e-wallet, UPI, or accessible bank deposits. 

Investing in liquid assets like bonds, stocks, and real estate, thus, demand for money is capitalized, along with offering investment opportunities. It is an important topic in economics because working professionals need it for policy making and economic analysis.

What is Demand for Money?

The demand for money is related to the income of individuals, interest rates, and the preference of individuals to hold money to make investment decisions. The money demand in economics refers to how individuals can hold money for future investments and assets. Further learn about the factors, types and theories related to demand for money.

Key Factors Influencing the Demand For Money

The theory of demand for money is influenced by several factors that contribute to its fluctuations in cash flow. These elements ensure that money plays a crucial role in capitalizing on future investment opportunities.

Interest rates - With increasing interest rates, holding money is not very advantageous. However, it represents a forgone opportunity where you can earn returns on an alternative investment on assets like bonds.

Income - With the income rising, the demand for money also increases. With the increasing price of products and services in the market, people need more money for transactions, along with potential precautionary holdings.

Level of Transactions - With the increasing economic transactions, the demand for money increases. Accordingly, the exchanges are facilitated.

Liquidity Preference - a core reason for the demand for money increasing is the desire to hold assets in the most readily spendable form, the liquid assets.

Types of Demand for Money

The demand for money depends on various factors, especially interest rates and income. Due to various reasons, money is demanded in today’s world. Henceforth, learn more about the different types, along with having a clear idea of the functions of money. Below are the three types of demand for money:

Precautionary demand - the demand for money needed for financial emergencies

Transaction demand - the demand for money needed for goods to buy, which is directly related to income

Speculative demand/ Asset motive - the demand for money is based on holding the money to buy bonds and assets in the future, basically making risky investments

Relation to Keynesian Economic Theory

The demand for money is an integral part of the central role in Keynesian economic theory, where people allocate wealth. Along with how interest rates and monetary policy are affected by the broader economy. It can be identified as a money measurement concept, especially when evaluating the motives. Introduced by John Maynard Keynes, there are three motives for holding money.

Motives for Holding Money (Keynesian Economic Theory)

The demand for money highlights the desire of institutions and individuals to hold money instead of other forms of wealth, like physical assets, stocks, or bonds. The Keynesian theory of employment establishes the stability of income. Here are three motives to hold money for various purposes classified by economists.

Speculative motive - Hold money to benefit from anticipated changes in financial assets, like buying bonds at a higher price in the future

Transaction motive - Hold money to meet ongoing expenses and daily needs, like paying bills

Precautionary motive - Hold money to meet unexpected future crises or emergencies, like medical treatment

Motive	Purpose	Depends On	Example
Speculative	Profit & investment opportunities	Expectations, interest rates	Holding cash to buy bonds for later
Transaction	Daily Expenses	Payment frequency, income	Paying bills, buying groceries
Precautionary	Unexpected events, emergencies	Availability of credit, uncertainty	Sudden repairs, medical bills

Other Theories Related to Demand for Money

There are other significant theories related to one of the most important concepts in economics, the demand for money. Most of these theories are interrelated with the determinants and dynamics of money. Additionally, the theories also contribute to the different insights you can develop as an economics student or working professional about income, mixed economy, interest rates and future expectations.

Classical theory - People want to keep money to only buy goods, not to invest or save

Keynesian theory - People’s choice is influenced by motives that prefer liquidating assets

The Quantity theory of money - the price level is directly linked to the money supply in an economy 

Friedman’s Permanent Income hypothesis - the demand for money is analysed through the expected long-term income instead of the current income

Baumol-Tobin model - the holding of cash and the holding of interest-earning assets is integrated with a profitable balance, thus analysing the trade-off

Life Cycle hypothesis - the stages of an individual’s life are used to define the demand for money in light of their expected income

Concluding Demand for Money

The demand for money is a significant component for economic students and working professionals. It indicates the preferences of businesses and people in terms of liquidity due to various changes occurring in the economic conditions. With various motives behind holding money, individuals and businesses can ensure stability as they learn how to effectively use the demand for money concept.

Read More

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• Theory of Cost
• Average Cost
• Capital Market
• Unit Trust of India
• Difference between Physical Capital & Human Capital

Frequently Asked Questions (FAQs)

How does the interest rate affect the demand for money?

The interest rate affects the demand for money, as the higher the rate, the lesser the speculative demand. It is because people prefer to invest in bonds instead of holding idle cash.

Which modern economist linked money demand with wealth and assets?

The modern economist, Milton Friedman, is the one who links money demand with assets and wealth.

What is the role of demand for money in inflation control?

The money demand increases more than the money supply, which leads to the building of inflationary pressure. This is where Central banks adjust the money supply in the market, and this is where the role of demand for money is defined.

Who gave the Liquidity Preference theory?

The Liquidity Preference theory is another theory that is related to the Demand for Money. The theory was offered by J.M. Keynes.

How has digitalisation affected demand for money?

With the increasing digitalization, the demand for physical money, like holding cash on your person, has significantly decreased. However, the demand for money via e-wallets and UPI has increased based on the changing monetary landscape.