Total Demand for Money

While analyzing the demand for holding money, it is found that there are different motives behind such demands. It shows as to why the community demands the money balances and how the amount of money balances for different motives is determined. Many economists; however, argue that such a classification for money is unnecessary and useless. It is argued that the demand for money should be considered as a complete whole instead of dividing the demand for money artificially into three parts. People do not keep their money holdings into the three separate purses with each purse labeled as the transactions, precautionary and speculative money purse.

The total demand for money is a composite demand composed of the transactions, precautionary and speculative demands for money.

How much money is demanded at each combination of income and interest rate levels is determined by a number of factors and the most important of which have been indicated by Prof Chandler as detailed below:

  1. The nature and variety of substitute assets. If other assets available for holding are highly illiquid and risky, the demand for money is likely to be high;
  2. The wealth of the community: The richer the community, the greater will be the demand for money.
  3. The ease and certainty of securing credit: People like to hold larger money balances if the credit is not available easily or when its availability is uncertain.
  4. The system of payments in the community: The demand for money is affected by the frequency, regularity and correspondence between the time and amounts of money receipts and disbursements. The greater the frequency and regularity of receipts and disbursements, the smallest is likely to be the quantity of money demanded relative to expenditures. The greater number of transactions, the larger is the demand for money likely to be.
  5. Expectations as to future income receipts. The people will increase their demand for money balances when they fear that their future income receipts will be less certain and may decline seriously.
  6. Expectations as to prices: The people are in a position to hold money when they expect the prices to fall. In that case, the purchasing power of money rises and the value of goods depreciates relative to money.

In a nutshell, all these factors as mentioned above lead to increase the velocity of money in circulation which have adverse effects on the demand for cash balances. The active component of money balances which is held for transactions motive is a function of the level of income, rising as income rises. However, the asset demand for money is much affected by factors other than income; total wealth; level of sacrificed interest and profit yields; optimism; pessimism; and plain uncertainty about the future; expected changes in prices of goods and assets and expected changes in interest rates, all the speculative elements that any investments depend on.

The behavior of interest rate and the level of income within the capacity levels of the economy depend upon innumerable factors which can; however, be summarized in four functions; viz.,

  1. the consumption function and the saving supply function;
  2. the investment demand function;
  3. the money supply function and
  4. the demand function for money. The equilibrium levels of income and interest depends upon all these factors taken together.

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