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Demand for Money

Last Updated : 06 Apr, 2023
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Money is anything that is generally accepted as a medium of exchange, a store of value, a measure of value, and a means for the standard of deferred payment. Money considers everything that can be used for an accomplishment of a business transaction and settlement of the business claims like currency notes, coins, cheques, etc. There is not just one definition of money; instead, it can be defined legally, functionally, based on liquidity, and based on scope. 

What is Demand for Money?

Goods and services like rice, wheat, parlour, cleaning, etc., have demand in the market because they possess utility. However, money does not possess a utility that can measure or determine the satisfaction level of consumers. Therefore, the motive behind the demand for money in an economy is different. The three main motives for which money is needed or demanded by people are Transaction Motive, Precautionary Motive, and Speculative Motive. 

1. Transaction Motive

The transaction motive to demand money is for the conduction of day-to-day transactions. Transaction motive can be seen from the perspective of households(income motive) and business firms(business motive). Households demand money as they want their income to meet their household needs and expenditure. Business firms demand money to carry on their business activities. Therefore, the transaction motive for the demand for money is to meet the current transactions of business firms and individuals. As the income of an individual is not always constant; however, his/her expenditures are constant, they hold cash with them to bridge this gap between changing income and constant expenditure. 

According to Keynes, Transaction demand of money is positively associated with the level of income; i.e., higher the level of income, larger would be the size of money holdings for transactions. 

2. Precautionary Motive

The precautionary motive to demand money is the desire of individuals to hold cash with them for unforeseen contingent situations. People have a habit of saving money with them that can provide them for the risk of unforeseen situations, such as accidents, sickness, etc. The amount of money held by an individual as a precaution depends upon their nature and living conditions.  Besides, the demand for money for precautionary motives also depends upon the income level of the individual. If an individual has a high income, he/she will store more cash for contingencies. However, if an individual has less income, he/she will store less cash for contingencies. 

Generally, the reason behind holding cash for the transaction and precautionary motive directly depend on the income level of people. However, there is a difference between the Transaction Motive and Precautionary Motive. 

People hold money with a transaction motive for conducting ordinary day-to-day transactions. However, they hold money with a precautionary motive for fulfilling unforeseen contingent transactions. 

Holding money under transaction motive is convenient, and the money value in terms of other commodities is quite certain. However, holding money under precautionary motive depends on the uncertainty arising. It means that people hold more money in times of war or financial crisis like COVID, and less money in normal conditions. 

3. Speculative Motive

The speculative motive to demand money is the desire of individuals to hold cash as an alternative to different financial assets such as bonds, etc. It is presumed under speculative motive that individuals can hold money either in the form of cash balances or in the form of bonds. The decision of people regarding their holdings in bonds or cash balances depends upon their future expectations for the change in the interest rate or the capital value of assets/bonds. There is an inverse relationship between the interest rate and the market value of securities, like bonds. In other words, when the interest rate increases, the market value of bonds declines.  However, if the interest rate decreases, the market value of bonds rises. Therefore, the demand for money at high interest rates becomes less, and at low interest rates becomes high. 

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