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 Money
The 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 Curve
The money demand
curve 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
Velocity
The 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.