Question

Specify the three most important independent variables directly affecting the demand for money.

Answer 1

The 3 most important independent variables which determine money demand in the long run are inflation ,interset rate and real income . Inflation and interest rate effects negatively while income affects money demand positively. It may be defined as if inflation and interest rate increases money demand falls and vice versa. While if income increases money demand also increases and vice versa.

Effect of each factor individually :

1) Inflation: Low inflation increases demand for money because higher prices requires more money for a given amount of goods and services.And vice versa.

2) Interest Rate : Economists call this the speculative demand for money. Since cash and most checking accounts don't pay much interest, but bonds do, money demand varies negatively with interest rates. That means the demand for money goes down when interest rates rise, and it goes up when interest rates fall.

3) Real Income : A household with an income of $10,000 per month is likely to demand a larger quantity of money than a household with an income of $1,000 per month. That relationship suggests that money is a normal good: as income increases, people demand more money at each interest rate, and as income falls, they demand less.