Some of the key determinants of demand for money specified by Friedman are: 1. With this strategy, the household has an average daily balance of $500, which is the quantity of money it demands. But to serve as a good proxy for wealth, a longer-term concept of income, like Friedman’s concept of ‘permanent income’, should be used in place of current income. The quantity of money people hold to pay for transactions and to satisfy precautionary and speculative demand is likely to vary with the interest rates they can earn from alternative assets such as bonds. The transactions demand for money is money people hold to pay for goods and services they anticipate buying. Putting those three sources of demand together, we can draw a demand curve for money to show how the interest rate affects the total quantity of money people hold. For simplicity, we can think of any strategy that involves transferring money in and out of a bond fund or another interest-earning asset as a bond fund strategy. Broadly speaking, the demand for money is thought to depend on three major factors: (a) total wealth to be held in various forms of assets; (b) relative price of and return on one form of wealth as compared to the other forms; and (c) tastes and preferences of the wealth-holders. One such variable suggested by Fried­man is ‘the degree of economic stability expected to prevail in the future’. The expected rates of return on money and other assets and 4. As is the case with all goods and services, an increase in price reduces the quantity demanded. The expected rates of return on money and other assets: This is the analogue of the prices of a commodity and its substitutes and complements in the theory of consumer demand. The transactions demand for money arises because people and firm use it as a medium of exchange. Income, as we know, includes both property income and labour income. Before publishing your Article on this site, please read the following pages: 1. TOS 7. But money is demanded for the services it yields and these services arise because of money… However, it is difficult to express this variable quantitatively. Household attitudes toward risk are another aspect of preferences that affect money demand. The division of wealth between human and non-human forms, 3. Of course, the bond fund strategy we have examined here is just one of many. As such the standard theory of demand for consumer goods can be applied to the demand for money. (c) Option of holding transactions funds in the form of money or risk-free income-yielding bonds (or non-money financial assets) and (d) Given cost in exchanging bonds for cash per transaction. In evaluating the choice between holding assets as some form of money or in other forms such as bonds, households will look at the differential between what those funds pay and what they could earn in the bond market. Bond is considered to be a perpetual security, or consol, which yields an income stream whose value, is fixed in nominal terms. Holding bonds is one alternative to holding money, so these same expectations can affect the demand for money. Figure 10.7. The demand curve for money shows the quantity of money demanded at each interest rate, all other things unchanged. They will hold smaller speculative balances. As we have seen, bonds pay higher interest rates than money deposits, but holding bonds entails a risk that bond prices might fall. The ultimate wealth-holders are households. PreserveArticles.com: Preserving Your Articles for Eternity, Short Essay on the Friedman’s Wealth Theory of Demand for Money. The equity is identical to the bond except that it contains a cost- of-living escalator so that its income stream always maintains constant purchasing power. Second, people are more likely to use a bond fund strategy when the cost of transferring funds is lower. The nominal rate of return on money may be zero as on currency or positive as it is on savings deposits, a large part of which is counted as demand deposits, or even negative, if current-account deposits are subject to net service charges. The household would thus have $3,000 in the checking account when the month begins, $2,900 at the end of the first day, $1,500 halfway through the month, and zero at the end of the last day of the month. For a month with 30 days, that is $100 per day. Our example does not yield a clear-cut choice for any one household, but we can make some generalizations about its implications. Total wealth, 2. Plagiarism Prevention 4. After 10 days, the money in the checking account is exhausted, and the household withdraws another $1,000 from the bond fund for the next 10 days. They will therefore increase the quantity of money they demand. At the beginning of the month, the household deposits $1,000 in its checking account and the other $2,000 in a bond fund. When you carry money in your purse or wallet to buy a movie ticket or maintain a checking account balance so you can purchase groceries later in the month, you are holding the money as part of your transactions demand for money. It spends an equal amount of money each day. A higher interest rate in the bond market is likely to increase this differential; a lower interest rate will reduce it. The bond fund approach generates some interest income. The creation of savings plans, which began in the 1970s and 1980s, that allowed easy transfer of funds between interest-earning assets and checkable deposits tended to reduce the demand for money.

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