Demand of Money
EVOLUTION OF MONEY
• Money was developed according to needs &
Requirements.
• Main aim was to remove the shortcomings of
the Barter System.
DIFFERENT STAGES OF EVOLUTION OF MONEY
1.
2.
3.
4.
5.
COMMODITY MONEY
METALIC MONEY
PAPER MONEY
CREDIT MONEY
ELECTRONIC MONEY
1. COMMODITY MONEY
– When different commodities were used as a
medium of exchange (BARTER SYSTEM)
– Cow Heads, Goats, Axes, Dried Fishes etc were
used as medium of exchange.
3. PAPER MONEY
PAPER MONEY
• Refers to the Notes issued by the State or by
the Bank, usually the Central bank.
• Paper Money can be:
1. Representative Paper Money.
2. Convertible Paper Money.
3. Fait Paper Money.
3. PAPER MONEY
Representative Paper Money.
It is that money which is fully backed by equivalent
metallic reserves.
Convertible Paper Money
Which is convertible into coins on demand.
Fait Paper Money
Which is not redeemable or convertible into Gold or
Silver on demand. It is accepted because it is
declared legal tender by the issuing authority and
has general acceptance as a medium of exchange.
The intrinsic value of Fait money is Nil.
4. CREDIT MONEY
• Includes Bank money (different instruments
offered by the Banks.)
• Cheques, Drafts, P.O, T.C are examples.
• Convenient, Safe and easily convertible into
cash.
• Its like Near Money.
5. ELECTRONIC MONEY
Electronic money (also known as e-money,
electronic cash, electronic currency, digital
money, digital cash or digital currency) refers
to money or scrip which is exchanged only
electronically. Typically, this involves use of
computer networks, the internet and digital
stored value systems.
CHARACTERISTICS OF MONEY
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General Acceptability.
Stability of Value.
Transportability.
Storeability.
Divisibility.
Homogeneity.
Cognizability.
Malleability.
LEGAL TENDER.
“ Means of payment, which has state’s sanction
behind it and can be used to settlement of
Debt obligations”
• Debtor can compel creditor to accept it.
1. Unlimited Legal Tender.
2. Limited Legal Tender.
LEGAL TENDER.
Unlimited Legal Tender.
• Money in terms of which debt can be legally
paid up to any amount.
• All type of Currency Notes.
Limited legal tender.
• Money in which debt can be paid to a certain
limit.
• 50 Paisa Coins.
MEASURING MONEY
• Changes in the amount of money in the
economy are related to changes in Interest
rates, Economic Development & Inflation.
• Inflation: rise in price level; makes the value of
the money less.
• Measured by Money Aggregates M1, M2, M3.
MEASURING MONEY
M1:
• Currency and checkable Deposit Accounts and other bank money
instruments.
• Most Liquid assets of a Financial System.
M2:
• M1 + Those assets which can’t be used directly as a mode of
payment and converted into currency.
• Saving account deposits
M3:
• M2+ Time deposits.
• Assets which are important to large institution and not to
individuals.
• M0
• Base money or amount of money actually issued by the central
bank . It is also the reserve requirements of commercial banks.
DEMAND FOR MONEY
• store of value An asset that can be used to
transport purchasing power from one time period
to another.
• liquidity property of money The property of
money that makes it a good medium of exchange
as well as a store of value: It is portable and
readily accepted and thus easily exchanged for
goods.
• unit of account A standard unit that provides a
consistent way of quoting prices.
• Standard of deferred payment
DEMAND FOR MONEY-Classical theory
• Quantity theory of money: The Transaction
Motive: MV=PT
• Velocity= nominal GDP/nominal money stock=
PY/M
• Quantity theory of money: The Income
approach: Md=kPY where Y is nominal income
• Md is directly proportional to real income or
Md/P (real money demand) = kY . Thus k=1/V
• Velocity is constant and does not depend on i or
Y.
DEMAND FOR MONEY-Keynesian
theory
• Keynes focused on three motives- transaction,
precautionary and speculative.
• Aggregate speculative demand for money has
inverse relation with current level of interest
but upto a point. At low level of interest rates
interest elasticity of money demand is infinite.
• Demand for money depends on prices,
interest rates and real income.
Money demand function
• Md=P* L(Y,i) where i is nominal int. earned on
non-monetary assets.
• Md= P.L(Y, r+∏) where r is real rate of interest
and ∏ is inflation rate.
• Md/P= L(Y, r+∏)
• Other factors
– Wealth
– Risk
– Payment technologies
Monetarist approach
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Md/P=h/i *Y
Md/P is demand for real balances
h/i is propensity to hold money
When the interest rate is very high everyone
expects it to fall in future and hence anticipates
capital gains from bond-holding. Hence people
convert their money into bonds. Thus,
speculative demand for money is low. Hence
speculative demand for money is inversely
related to the rate of interest.
Other factors affecting money demand
• Demand for consumer spending
• Uncertainty about future(precautionary demand)
• Transaction costs to buy and sell stocks and
bonds
• Inflation
• Demand for exports
• Demand for domestic investments by foreigners
• Central bank’s currency holding
Supply of Money
• M1 = CU + DD
• M2 = M1 + Savings deposits with Post Office
savings banks
• M3 = M1 + Net time deposits of commercial
banks
• M4 = M3 + Total deposits with Post Office
savings organisations (excluding National
Savings Certificates)
Determinants of money supply
• Monetary base- money issued by the Govt and
central bank of India.
• CRR and SLR
• Levels of bank reserves
• Discount policy rates
• Public desire to hold currency
• Public desire to hold deposits with banks
• Price change
• Exchange rate