DEMAND FOR MONEY

 THE DEMAND FOR MONEY

• Having understood the role of money in an economy, we shall now examine the concept of demand for money. If people desire to hold money, we say there is demand for money. As we are aware, the demand for money is in the nature of derived demand; it is demanded for its purchasing power. Basically, people demand money because they wish to have command over real goods and services with the use of money. 
• Demand for money is actually demand for liquidity and demand to store value. The demand for money is a decision about how much of one’s given stock of wealth should be held in the form of money rather than as other assets such as bonds. Although it gives little or no return, individuals, households as well as firms hold money because it is liquid and offers the most convenient way to accomplish their day to day transactions.
• One might think why is it important to study about demand for money? Demand for money has an important role in the determination of interest, prices and income in an economy. The role of money in the macro economy is usually examined in a supply/demand framework.Before we go into the theories of demand for money, we shall have a quick look at some important variables on which demand for money depends on. 
• The quantity of nominal money or how much money people would like to hold in liquid form depends on many factors, such as income, general level of prices, rate of interest, real GDP, and the degree of financial innovation etc. Higher the income of individuals, higher the expenditure and richer people hold more money to finance their expenditure.
•  The quantity is directly proportional to the prevailing price level; higher the prices, higher should be the holding of money. As mentioned above, one may hold his wealth in any form other than money, say as an interest yielding asset. It follows that the opportunity cost of holding money is the interest rate a person could earn on other assets. 
• Therefore, higher the interest rate, higher would be opportunity cost of holding cash and lower the demand for money. Innovations such as internet banking, application based transfers and automatic teller machines reduce the need for holding liquid money. Just as households do, firms also hold money essentially for the same basic reasons.