A note on ..............Demand for money

•Demand for money balance is liquidity preference.

•Whether to hold cash or put it in savings bank so as to earn interest.

•People desire to hold money balance from   two motives —

•1. The Transaction Motive

•2. The Speculative Motive

Transaction motive

•Holding money for transactions

•Transaction demand for money in an economy,  Mt  can be written as

 v.Mt  = T 

Where,  v is velocity of circulation of money

•             T is the total value of transaction in the economy.

Velocity

• the rate at which money circulates

•definition:  the number of times the average rupee changes hands in a given time period

•example:  In 2010,

•Rs.500 crores in transactions

•money supply = Rs.100 crores

•The average Rupee is used in five transactions in 2010

•So, velocity = 5

•speculative motive

•Demand for money for speculation is speculative motive.

•Speculative demand for money can be written as

•Mͩs =  rmax -  r/ rmin - r               r = market rate of interest

                                               

As r decreases from r max to r min, the value of Mͩs  increases from 0 to infinite.

Liquidity trap

•It’s a situation where the speculative money demand function is infinitely elastic.

                                      

Thus,   Demand for Money  =  Transaction demand for money +   Speculative demand for     money