Money Demand Essay

4403 words - 18 pages

Macro Notes 3: Money Demand 3.1 Demand for Money The notion of a demand for money may strike you at first glance as bizarre. Don't you just want as much as you can get? Or isn't money what you use when you demand other goods? Here is where we have to remember that money is a stock not a flow, and that income and wealth are not money. Demand for money is a question of how much of your wealth you wish to hold in the form of money at any point in time. (Supply of money is also a stock concept.)Your demand for money is how much of your wealth you wish to hold as money at any moment in time. It is thus a stock demand. Your wealth is a stock, and you must decide how to allocate that stock of wealth between different kinds of assets -- for example a house, income-earning securities, a checking account, and cash.Why would you hold any of your wealth as money -- as cash or checking deposits? Those assets earn little or no interest. Wouldn't it be more sensible to hold all your wealth in the form of assets that yield income? Note that:1. There is a cost associated with holding money balances (you give up interest payments),2. There is no intrinsic value in the money balances you hold except in their use as a medium of exchange. Generally, you acquire money in order to get rid of it -- to buy things. While you hold it, money does not keep you warm, entertain you, or provide any other benefit.Economists identify two reasons why people will demand money balances, or desire to hold a certain stock of money even if there is no intrinsic value for the money balances they hold. 3.2 Transactions Motive for Holding Money The most obvious answer is that we hold some money because it's convenient to buy stuff with. We'll call this first reason the transactions motive. Essentially, it's convenient to hold a certain average amount of money at any given time, depending on the kind of purchases you make and the size of your income.One of the most important functions of money is that it is the universally accepted medium of exchange -- this is the main reason you hold money. Thus, one reason to hold money is to use it as a means of payment in transactions in the future. Now, if there was a perfect match between the moments you receive money in transactions and the moments you use money, you would not need to hold any money at all. If I were paid every Friday, and I could pay all my bills on the same day, then I would need to hold very little money.Unfortunately, in the real world, there is not going to be an exact match between when I receive money and when I need to make payments. Let us say that as a work study student, you receive $500 every month as payment for your work. This payment comes once a month. But you need to pay for rent, food, movies, books, copying, pens etc. This is spread out over the month. So, on the first of the month, you deposit $500 in you bank account at Fulton bank, and then you withdraw this money and run your account down to zero over the...

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