THE DEMAND FOR MONEY

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 Motives for holding Liquidity

 There are three motives for holding

liquidity, namely;
1. Transaction Motive
2. Precautionary Motive
3. Speculative Motive
  

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 Transaction Demand for
Money

The transaction demand for money

relates to ‘medium of exchange’
function of money. The transaction
motive can be further split up as
a. Income Motive and
b. Business motive

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 Income Motive:

Where the amount of money that a consumer will

hold to satisfy the transaction motive will depend on
two factors:
 Size of one's income: Obviously, a person holds
more money for transaction when his income
increases and vice versa.
 Interval of time: Interval of time between the receipt
of income and its expenditure also influence the
transaction demand for money. Bigger the gap
between income and its expenditure larger the
demand for money and vice versa. 

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 Business Motive

Where money balance for business

depends on
 Amount of turnover: Larger the turnover of
business, the larger will be the demand for
money to satisfy the business motive.
 Average collection period: The shorter the
period required to collect dues of credit
sales the smaller is the demand for money

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 2. Precautionary Demand for
Money

The Precautionary Motive is Represented by

Unforeseen expenses in the future and Affected by
1. Uncertainty about the future arising out of
optimism, pessimism
2. Expected changes in the price of goods and
assets
The precautionary demand for money is income-
determined. That is higher the level of income,
greater is the capacity of people to hold cash
balances to meet future contingencies.

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 Transaction vs Precautionary
Demand for Money
The similarity between the transaction motive and
income motive is that both are income-
determined. That is if income goes up the
demand for liquidity also goes up.
The dissimilarity The amount of money held for
Transaction motive varies in direct
proportion to the value of transaction taking
place in a given time in a country, while the
money holdings for precautionary motive
vary significantly with the degree of
uncertainty.

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 Speculative Demand for Money

It represents the demand for liquid

balances for being invested readily as the
most attractive opportunities for monetary
investment.
This demand arises from future uncertainty
of the rate of interest.
The speculative demand for money is quite
elastic as it is most sensitive to the
financial investors’ expectations regarding
the future trends in the rate of interest.
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 Speculative Demand for Money

As the rate of interest rises the price of

fixed income yielding assets are likely to
fall and vise versa.
The transaction demand and
Precautionary demand for money is
income-determined and interest inelastic
While the Speculative demand for money
is income determining as well as interest
elastic

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 Factors Influencing the Demand for money

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.
On the other hand if variety of short term
and long term financial assets like Prize
bond, treasury bond and shares etc are
available then the demand for holding
money will be reduced.

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 Factors Influencing the Demand for money
The ease and certainty of security credit:
Lack of certainty and availability of crredit
creates more demand for money-holding.
On the other hand, if there are ample
opportunities to get credit in plenty and
under easy terms and conditions then
people will need lesser amount of money to
be held.
The rate of Interest
The rate of interest. In other words the cost
fund in the economy
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 Factors Influencing the Demand for money

The wealth of the community:

The richer the community , the greater is
the demand for money. On the other
hand if the community is poor the
demand for money will be lessen.
The system of payment in the community
The greater the frequency of receipt and
disbursement , the smaller the demand
for money.
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 Factors Influencing the Demand for money
 Expectations as to future income receipts
 If there is fear to reudce future income
receipt, people will increase their
demand for money balances and vice
versa
 Expectations as to prices
 If people expects price to fall the demand
for holding money will be high and vice
versa
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 The Demand for Money in an Islamic
econaomy
 An Islamic demand for money is
basically derived from transaction and
precautionary need that are determined
by the level of money income and its
distribution.
 If money income of an Islamic
community goes up the demand for
money income will also goes up and vice
versa.
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 The Demand for Money in an Islamic
econaomy

 On the other hand given a level of aggregate

money income demand for money is largely
influenced by the pattern of distribution.
 The more equitable the distribution of income,
the greater will be the demand for money and
vice versa.

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 The Demand for Money in an Islamic
econaomy
 The speculative demand for money that
is the soul of all charisma of capitalist
economy is not acceptable in an Islamic
monetary system.
 Liquidity preference arising from the
speculative motive should be very much
insignificant in an Islamic economy
because of the following reasons:

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 Why Speculative Demand is
insignificant in Islamic economy
1. Liquidity preference is helpful in the case
of interest-bearing securities and assets
because waiting could mean higher
earnings when interest rates rise.
So far interest-bearing securities would just
not be available in an Islamic economy; the
liquidity preference to exploit the future
higher rate of interest would be
disappeared.

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 Why Speculative Demand is
insignificant in Islamic economy
2. In an Islamic economy if people are
accumulating savings and holding it
without going for productive investment
then the accumulated savings will be
diminishing over time because of the
compulsory payment of Zakat at the rate of
two-and –a-half per cent per annum.
3. Although inflation is not desirable in
Islam still sometimes unavoidable
situations may arise when
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The Supply of Money in an Islamic economy
 The supply of money by an Islamic central bank
should have the following guiding objectives:
 That the supply of money neither be inadequate
nor excessive rather sufficient to complete the
transactions of the goods and services
produced in an economy for a given period of
time.
 That the supply of money should be adequate to
finance the growth in output over time to exploit
fully the capacity of the economy to supply
necessary goods and services for the welfare of
the people.
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The Supply for Money in an Islamic economy
 That the value of money is not eroded and
stability of prices maintained.
 That unemployment is reduced to maximum
extent and ensures justice and economic
distribution of income and wealth.
 That mobilization and investment of savings
for productive purposes is ensured in an
equitable manner so that a just return is
ensured to all parties concerned.

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