Question

1. Discuss the demand of money. What can shift the money demand curve? Give some real-world examples.

Answer 1

Demand of money is the desired holding of financial assets in the form of money: that is, cash or bank deposits rather than investments. It can refer to the demand for money narrowly defined as M1 (non-interest-bearing holdings), or for money in the broader sense of M2 or M3.The demand for money is a result of this trade-off regarding the form in which a person's wealth should be held.

Generally, the nominal demand for money increases with the level of nominal output (price level times real output) and decreases with the nominal interest rate. The real demand for money is defined as the nominal amount of money demanded divided by the price level.

The LM curve, the equilibrium points in the market for money, shifts for two reasons: changes in money demand and changes in the money supply. If the money supply increases (decreases), ceteris paribus, the interest rate is lower (higher) at each level of Y, or in other words, the LM curve shifts right (left).

Factors that influence prices include:

• Changes in disposable income
• Changes in tastes and preferences
• Changes in expectations
• Changes in price of related goods
• Population size

Factors that change the demand include:

• Decrease in the price of a substitute
• Increase in the price of a complement
• Decrease in consumer income if the good is a normal good
• Increase in consumer income if the good is an inferior good

The demand for money shifts out when the nominal level of output increases. It shifts in with the nominal interest rate.

For example, if a stock market crash seemed imminent, the speculative motive for demanding money would come into play; those expecting the market to crash would sell their stocks and hold the proceeds as money. The presence of a speculative motive for demanding money is also affected by expectations of future interest rates and inflation. If interest rates are expected to rise, the opportunity cost of holding money will become greater, which in turn diminishes the speculative motive for demanding money. Similarly, expectations of higher inflation presage a greater depreciation in the purchasing power of money and therefore lessen the speculative motive for demanding money.

(Image copied from.third party for easy understanding)