Question

1. What are three motives of money demand according to Keynes?
2. What is equation linking velocity and demand for money?
3. What is the impact on velocity as a result of
   1. Economy goes in to a recession
   2. Credit cards are made illegal

iii. Interest rate rises

Answer 1

(A) Transaction motive: To make transactions, we need money in hand. This is the first and primary motive to demand for money.

Precautionary motive: In case of emergency needs, we need money. People demand money for precautionary use.

Speculative motive: People demand money with the goal to earn interest on money by investing it in bonds or other interest earning assets.

(B) The Equation is: MV = PY

M = Quantity of money

V = Velocity of money (how frequent money changes hand in the economy)

P = Price level

Y = Output level

(C) (i) As economy goes into recession, the aggregate demand for money falls and so does the velocity of the money.

(ii) As credit cards are made illegal, it means people has to use cash or money in hand, this will increase the velocity of the money.

(iii) As interest rate rises, people will invest more of their money into interest earning assets, and keep less money in hand. The velocity of money falls.