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. COMMODITY MONEY2. METALIC MONEY3. PAPER MONEY4. CREDIT MONEY5. 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 MONEYRepresentative Paper Money.

It is that money which is fully backed by equivalent metallic reserves.

Convertible Paper MoneyWhich is convertible into coins on demand.

Fait Paper MoneyWhich 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

• 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 MONEYM1:• 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 depositsM3:• 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

• 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