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Explain the concept of Demand for Money?

by Puja

The Classical Approach – demand for money:

The classical economists didn’t explicitly formulate demand for money theory but their views are inherent within the quantity theory of money. They emphasized the transactions demand for money in terms of the rate of circulation of cash This is often because money acts as a medium of exchange and facilitates the exchange of products and services. In Fisher’s “Equation of Exchange”.


Where M is that the total quantity of cash, V is its velocity of circulation, P is that the price level, and T is that the total amount of goods and services exchanged for money.

The right hand side of this equation PT represents the demand for money which, in fact, “depends upon the worth of the transactions to be undertaken within the economy, and is adequate to a constant fraction of these transactions.” MV represents the supply of money which is given and in equilibrium equals the demand for money. Thus the equation becomes

Md = PT

This transactions demand for money, in turn, is by the extent of full employment income. This is often because the classicists believed in Say’s Law whereby supply created its own demand, assuming the full employment level of income. Thus the demand for money in Fisher’s approach may be a constant proportion of the extent of transactions, which successively, bears a continuing relationship to the extent of value. Further, the demand for money is link to the volume of trade happening in an economy at any time.

Thus its underlying assumption is that individuals hold money to buy goods.

But people also hold money for other reasons, like to earn interest and to supply against unforeseen events. It’s therefore, impracticable to say that V remains constant when M is modify. The foremost important thing about money in Fisher’s theory is that it’s transferable. But it doesn’t explain fully why people hold money. It doesn’t clarify whether to incorporate as money such items as time deposits or savings deposits that aren’t immediately available to pay debts without first being converted into currency.

The Cambridge cash balance approach which raised an extra question: Why do people actually want to carry their assets within the form of money? With larger incomes, people want to form larger volumes of transactions which larger cash balances will, therefore, demanded.

The Cambridge demand equation for money is


where Md is that the demand for money which must equal the supply to money (Md=Ms) in equilibrium within the economy, k is that the fraction of the important money income (PY) which individuals wish to carry in cash and demand deposits or the ratio of money stock to income, P is that the price level, and Y is that the aggregate real income. This equation tells us that “other things being equal, the demand for money in normal terms would be proportional to the nominal level of income for every individual, and hence for the mixture economy also.”

Its Critical Evaluation:

This approach includes time and saving deposits and other convertible funds within the demand for money. It also stresses the importance of factors that make money more or less useful, like the costs of holding it, uncertainty about the future then on. But it says little about the character of the relationship that one expects to prevail between its variables, and it doesn’t say too much about which ones could be important.

One of its major criticisms arises from the neglect of store useful function of cash. The classicists emphasized only the medium of exchange function of money which simply acted as a go-between to facilitate buying and selling. money performed a neutral role within the economy. It barren and wouldn’t multiply, if stored within the form of wealth.

This is an erroneous view because money performed the “asset” function transformed into other sorts of assets like bills, equities, debentures, real assets (houses, cars, TVs, then on), etc. Thus the neglect of the asset function of cash was the main weakness of classical approach to the demand for money which Keynes remedied.

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