The Demand And Supply Of

Money

What Is Money?
Money is any asset that serves as a unit of

account and can be used as a medium of

exchange for economic transactions.

It is all assets that have a high degree of

liquidity.

Money also serves as a store of value, but it

is not unique in this role.

Contd.

Unit of account
Medium of exchange
Store of value

Why Do We Need Money?

The Demand For Money:

The demand for money represents the desire of

households and businesses to hold assets in a form
that can be easily exchanged for goods and
services.
Spendability, or liquidity, is the key aspect of
money that distinguishes it from other types of
assets. For this reason, the demand for money is
sometimes called the demand for liquidity

Types Of Demand

Demand For Money

Transactions Demand
Speculative Demand
Precautionary Demand

Transactions Demand
People hold money because they hope to make

transactions for goods and services in the future

How much money we hold depends upon the value
of transactions we expect in the future.
Similarly the total value of all transactions in the
economy during a period of time would influence
the aggregate transactions demand for money.
GDP, the value of all goods and services produced
during the year, will influence the aggregate value
of all transactions since all GDP produced will be
purchased by someone during the year.

GDP rises

More
transactions
needed to
buyNominal
extra
here is
GDP

More
Demand for
money
GDP(GDP
at

GDP referred to
exisiting prices).
Nominal GDP=Real GDP x P
(Real GDP-GDP after eliminating the effect of price
changes that have occurred since the base year)
Therefore because Transactions demand for money
increases with increase in nominal GDP , it also
changes with change in prices and/or change in
real GDP

 GDP will rise Transactions demand for money will

rise ,If:
(a) the amount of goods and services produced
in the economy rises while the prices of all
products remain the same.
(b) if the average prices of goods and services

produced in the economy rises, then even if the

economy produces no additional products, people
will still demand more money to purchase the
higher valued GDP, hence the demand for money to
make transactions will rise.

Speculative Demand
Speculative demand is the demand for financial

assets,such as securities, money or foreign

currency that is not dictated by real transactions
such as trade, or financing.
Refers to real balances held for the purpose of
avoiding capital loss from holding bonds.
Assets demand for money is the money held by
people to avoid the risk of capital loss due to
holding other financial assets, e.g., bonds, equities,
long-term bonds, etc., because these assets have
variable market values

 The assets demand for money is proportional to the

risk involved in selling the asset.

People would rather hold their money in liquid form
than investing it in an asset whose future value is
unpredictable.
It depends on investors aversion to risk, the relative
demand for and the supply of other financial assets
and real assets and the change in expectations of the
economic climate.

Precautionary Demand
Precautionary money is held for unexpected

transactions such as car repairs or medical bills,

although does not need to be limited to serious
expenses or needs.

Supply Of Money
Money has value because of the relative availability.

If money were as plentiful as grains of sand on all the

worlds beaches, it would have no value.
Just like shares of stock, money is similar in that it
symbolizes a claim on assets.
If you have a ten-dollar bill, it represents your claim
to ten dollars worth of goods or services. However, if
that ten-dollar bill represents such a small fraction of
all bills in existence, it is virtually worthless.

Supply Of Money
Different measures
M1 is the base measurement: cash in the hands
of the public(coins and currency)
M2 is equal to M1 plus savings deposits, money
market accounts, overnight repurchase agreements
M3 equals M2 plus institutionally held money
market funds, term repurchase agreements
L,the fourth measure, is equal to M3 plus
Treasury bills,commercial papers, banker's
acceptances, and very liquid assets such as savings
bonds.

Why Can't the Government Print Money

and Make Everybody Wealthy?
The reason is because there would be a large supply of

money relative to the goods produced and the value of

the rupee will fall.
We really don't desire money for the sake of holding
additional pieces of paper. We desire it to purchase more
things. The more things we are able to purchase, the
wealthier we are.
On a relative scale, when there is more money than
products(lets say bank accounts of people get doubled
overnight!) things appear a little cheap and people act
accordingly and get in line to buy. The retailers cannot
handle the excess demand so they raise the prices to a
point where they are in equilibrium and supply equals
demand to a point where prices are exactly doubled.

Contd.
This phenomenon is often called the quantity

theory of money. It states that a given money

supply is spent over and over (called the velocity of
money) on goods and services throughout the year.
Money Supply * Velocity = Prices * Quantity
Velocity is the rate at which people spend and Q is
the quantity of goods and services produced.These
remain fairly constant over a given time
Thus If money supply increases, the prices will rise
in equal proportion to balance the equation

Contd.
So while the government does have the right and

the ability to print more money, the economic

forces of supply and demand prevent us from using
printing presses to create true wealth.
We can create more pieces of paper but youd find
that you are no better off than before.
The reason is that prices will be proportionately
inflated by the amount of cash in the system.

Thank You