Individuals and business firms economise on their holding of money balances by carefully managing their money balances through transfer of money into bonds or short-term income yielding non-money assets. Do you have a 2:1 degree or higher? With the given supply of money, the different levels of liquidity preference curves corresponding to various levels of income would determine different rates of interest. According to Keynes, there is a floor interest rate below which the rate of interest cannot fall. M1 is assets that are the most liquid of assets, and those that can most quickly be converted to cash. On the other hand, from Keynes’ formulation, the LM curve is obtained from a family of liquidity preference curves corresponding to various income levels together with the given stock of money supply. Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UKEssays.com. For Advanced-Economies. A number that is less than or equal to 0.05 is considered a small p-value. Cambridge economists did not provide any theoretical reason for its being equal to Unity. Demand for money means the desire of the people to hold their wealth in liquid form. This means that 95.79% of the predictors were true. The demand for money has a negative slope because of the inverse relationship between the speculative demand for money and the rate of interest. The factors which determine demand for money has been explained above. This decision about the portfolio balance can be influenced by two factors. The Keynesian theory of money demand emphasizes the importance of a) a constant velocity b) irrational behavior on the part of some economic agents ... Keynes's liquidity preference theory indicates that the demand for money is a) constant b) positively related to interest rates The cash held under this motive is used to make speculative gains by dealing in bonds whose prices fluctuate. The higher the interest rate, the greater the opportunity cost of holding money rather than non-money assets. Without a doubt as the economy continues to grow and change, there will continue to be a need for new theories and new ideas on how the demand for money develops and progresses. Thirdly, Don Patinkin and Milton Freidman have criticised Hicks-Hansen synthesis as being too artificial and over-simplified. It is clear that the amount of money held under this business motive will depend to a very large extent on the turnover (i.e., the volume of trade of the firm in question). Thus the demand for money balances is demand for real rather than nominal balances. BIBLIOGRAPHY “Liquidity preference” is a term that was coined by John Maynard Keynes in The General Theory of Employment, Interest and Money to denote the functional relation between the quantity of money demanded and the variables determining it (1936, p. 166). TOS 7. Cambridge Cash-balance approach to demand for money is illustrated in Fig. PT) and Md as PT represents the total amount of work to be done by money as a medium of exchange. The larger the turnover, the larger, in general, will be the amount of money needed to cover current expenses. To begin with, ON is the quantity of money available. Arguments state that it is not always possible to change supply and demand by lowering interest rates and increasing money supply. Prohibited Content 3. Thus, it is proportional function of both price level (P) and real income (F). The LM curve tells as what the various rates of interest will be (given the quantity of money and the family of liquidity preference curves) at different levels of income. Thus at different levels of income there will be different liquidity preference curve or money demand curve. A typical money-demand function may be written as 18.7 (b) we measure income (Y) on the X-axis and plot the corresponding rates of interest determined by the equality of savings and investment on the X-axis. If people are merely concerned with nominal money holdings irrespective of the price level, they are said to suffer from money illusion. As the income rises, the savings curve shifts to the right and the rate of interest which equalises savings and investment falls. Individuals hold cash in order “to bridge the interval between the receipt of income and its expenditure”. Plagiarism Prevention 4. Disclaimer 9. The notion of holding money for speculative motive was a new and revolutionary Keynesian idea. Narrow version. The Keynesian theory, like the classical theory of interest, is indeterminate. The interest rate is determined then by the demand for money (liquidity preference) and money supply. Rate of interest will be determined where the demand for money is in balance or equal to the fixed supply of money ON. If the rate of interest falls to Or’, then a greater amount of money OM’ is held under speculative motive. The demand for money is defined as the desired holding of certain cash and other financial assets in monetary form. M1 is the most often referenced money supply by economists who use it to show the amount of money that is circulating through the economy. First, income elasticity of demand for money is unity and, secondly, price elasticity of demand for money is also equal to unity so that any change in the price level causes equal proportionate change in the demand for money. Keynesian economists generally say that spending is the key to the economy, while monetarists say the amount of money in circulation is the greatest determining factor. However, as we have seen, liquidity preference, especially demand for money for transactions motive depends on level of income. Thus important feature of Cash-balance approach is that it makes the demand for money as function of money income alone. Disclaimer: This work has been submitted by a university student. As a result, the bond prices will go up which implies that the rate of interest will decline. These other influences remain in the background of the theory. This amount will depend upon the size of the individual’s income, the interval at which the income is received and the methods of payments prevailing in the society. And this reward is the rate of interest that must be paid to them in order to induce them to part with liquidity or money. i) The Quantity Theory of Money (Theory of Exchange) looks at money largely from the supply side while Keynesian approach is from the demand perspective (the desire for people to hold their wealth in cash balances instead of interest – earning assets such as treasury bills and bonds) The interest rate according to Keynes is given for parting with liquidity for a particular period of time. The above function implies that money held under the transactions and precautionary motives is a function of income. Where it is conceived that demand for money function (Md) is increasing-function of the level of income, it is a decreasing function of the rate of interest. Holding one’s asset in the form of money balances has an opportunity cost. Since the total money supply at a given moment remains fixed, it cannot be reduced by buying bonds by individuals. The Classical Approach: The classical economists did not explicitly formulate demand for money theory but their views are inherent in the quantity theory of money. The demand for money by the people depends upon how they decide to balance their portfolios between money and bonds. Therefore, Keynes emphasised another motive for holding money which he called speculative motive. The Keynesian Approach Liquidity Preference 3. The T-stat is calculated using the sample data in the hypothesis test. These tests are used to determine the accuracy of the claims made for population. Interest in the study of demand for money has been due to the important role that monetary demand plays in the determination of the price level, interest and income. The Liquidity Preference Theory says that the demand for money is not to borrow money but the desire to remain liquid. The businessmen and the entrepreneurs also have to keep a proportion of their resources in money form in order to meet daily needs of various kinds.
keynesian liquidity preference theory of money demand