The Demand for Money

Chapter 14-1

Opportunity Cost

There is an opportunity cost to holding money

Measured by the difference between interest rate on assets that are not money and interest on asset that are money.

The Demand for MoneyThe Opportunity Cost of Holding Money

Opportunity Cost

Foregone interest is the opportunity cost (price) of money people choose to hold.

The Demand for Money

The Opportunity Cost of Holding Money

Short-term interest rates are the interest rates on financial assets that mature within six months or less.

Long-term interest rates are interest rates on financial assets that mature a number of years in the future.

Price of Money

The Higher the Short-term Interest higher the Opportunity cost of holding money

The Lower the Interest rate Lower the opportunity cost of holding money

Price of Money

You could think of interest rate as the price of money.

So Why Hold Cash?

Transactions demand for money – Money held for the purpose of making everyday market purchases.

People hold money so they can buy goods and services.

There are other reasons too but your book stress only this one aspect

Why Hold Cash?

Precautionary demand for money – Money held for unexpected market transactions or for emergencies.

Another reason people hold money is for sudden emergency purchases.

Not in your text but something to think about!

Why Hold Cash?

Speculative demand for money – Money held for speculative purposes, for later financial opportunities.

Not in the textbook but something to think about!

The Money Demand CurveThe money demand money demand curvecurve shows the relationship between the quantity of money demanded and the interest rate.

The Liquidity Preference Model of the Interest Rate

True but Confusing

Pages 346 to 349 and the following slides covers an important idea

We will skip this part for now. This topic may lead to some confusion for some students because

The Author introduces Real Quantity of Money and ignore the idea till the end of the chapter.

Prices and the Demand for Money

The real quantity of money is the nominal quantity of money divided by the aggregate price level.

Prices and the Demand for Money

The Aggregate Price Level and Money Demand

The Real Demand for Money

The real money demand curve shows the relationship between the real quantity of money demanded and the interest rate.

Shift of Real Money Demand Curve*

Changes in Real Aggregate Spending

Changes in Technology

Changes in Institutions

VelocityThe velocity of money is nominal GDP divided by the nominal quantity of money.

According to the velocity of money approach to money demand, the real quantity of money demanded is proportional to real aggregate spending.

Money Velocity

The real demand for money, M/P, is proportional to real GDP, Y, where the constant of proportionality is 1/V.