Money: Motives, Demand and Supply,Elementary Quantity theory and value of money

CONTENT

• Motives for Holding Money
• Demand And Supply of Money
• Elementary Quantity Theory of Money
• Value of Money And Price Level

DEMAND FOR MONEY

Demand For Money: is the total amount of money which an individual, for various reasons, wish to hold. That is, it is the desire to hold money in terms of keeping one’s resources in liquid form rather than spending it. The demand for money in economics is known as Liquidity Preference.

MOTIVES FOR HOLDING MONEY

Reasons or motives for holding money in economics as postulated by Lord Menard Keynes are in three major ways as follows:

1. Transactionary Motives– is when people desire to hold money in liquid or raw cash for day-to-day transactions or to meet current expenditure. That is, to cater for the interval between the receipt of incomes and their expenditures
2. Precautionary Motives– is when people desire to hold money in liquid form in order to meet up with unforeseen contingency or unexpected expenditure which may include sickness, unexpected visitors, accidents, etc.
3. Speculative Motives– is when people desire to hold money specifically for a business transactions in order to embark on speculative dealings in the bond (security) market.

EVALUATION

1. Define demand for money
2. State and briefly explain the three motives for holding money

SUPPLY OF MONEY

This refers to the total amount of money available for use in the economy at a given period of time. The supply of money involves the currency in forms of bank notes and coins circulating outside the banking system as well as the bank deposits in current accounts, which can be withdrawn by cheque (i.e bank money).

FACTORS AFFECTING SUPPY OF MONEY

• Bank Rate- is the rate of interest which the Central Bank charges the commercial banks for lending money to or borrowing from them and discounting bills.
• Cash Reserve Ratio- also known as Cash or Liquidity Ratio, is the percentage of the deposits Commercial Banks are expected to keep with them. When the Cash Reserve is high, the supply of money will definitely be low, and vice-versa.
• Economic Situation- the Central Bank reduces the supply of money during the period of inflation and increases it during the period of deflation.
• Demand for Excess Reserves- when Commercial Banks demand for excess reserves, the supply of money will increase.
• Total Reserves of Central Bank- money supply is affected by the total reserve of the Central Bank. If the total reserve supplied by the Central Bank is high, money supply will also be high, and vice-versa.

EVALUATION

1. Define the term supply of money
2. List and explain the five factors affecting supply of money.

QUANTITY THEORY OF MONEY

The quantity theory of money was propounded by Sir Irving Fisher- an American Economist. Fisher postulated that the value of money depended on the quantity of it that is in circulation. Though this has been traditionally explained as the relationship between the quantity of money in circulation and the amount of production of goods and services within the economy. Fisher in his analysis stated that the total stock of money multiplied by the velocity of its circulation is equal to the total transactions multiplied by the price level.

The connection between money in one hand and output and price on the other can be formally stated by means of the Fisher’s identity known as the quantity theory equation. It is stated as, MV=PT, where M= Stands for the stock of money, V= Stands for the velocity of money, P= Stands for average price level, T= Stands for total volume of transaction.

Example:

From the quantity theory of money equation MV=PT. Assuming P=20, M=200,000 and T=20,000. Calculate the velocity of money (V)

Solution:

MV=PT

    V=PT/M

    V=20 x 20,000/200,000

    V=2.

The velocity of money (circulation) is a measure of the speed at which money changes hand in the economy and is determined by the rate at which money is passed from one person to another and the length of time for which money is held in form of wealth or asset.

CRITICISMS OF THE QUANTITY THEORY OF MONEY

The following criticisms were leveled against the quantity theory of money

1. It was more truism than a theory
   1. It rests mainly on the assumption that some variables are constant.
   1. Changes in prices may be as a result of other factors not included in the theory.
   1. Its claim to be a theory of money is wrong because it failed to discuss the effect of the rate of interest.
   1. It emphases much on the changes in the value of money and ignores the determinants of the original value of money.
   1. The theory did not recognize the demand for money and concentrated on the supply of money

EVALUATION

1. What do you understand by the quantity theory of money?

2. List four criticisms against the quantity theory of money.

THE VALUE OF MONEY

The value of money refers to the purchasing power of money. That is, the amount of quantity or goods and services money can buy with a given sum of money over a given period of time.

FACTORS THAT DETERMINE THE VALUE OF MONEY

1. The general price level
2. Inflation and deflation
3. Supply of money or velocity of money
4. Volume or Quantity of goods and services produced

EVALUATION

1. Explain the value of money
2. How is the value of money measured?

READING ASSIGNMENT

1. Amplified and Simplified Economics for SSS by Femi Longe pages 228-236
2. New Approach Economics By K.U Nnadi  and A.B.Falodun Chapter 13 pages 120-130
3. Fundamentals of economics by R.A.I. Anyanwuocha page 173
4. An Authority in Economics for  Senior Secondary School By Comrade Okoro   Francis O Pages 118-123

GENERAL EVALUATION QUESTIONS

1. What is labour force?
2. Explain four factor affecting the size of a country’s labour force
3. Explain the factors that determine the level of wages in your country.
4. Define term unemployment.
5. Highlight the effect of unemployment on an economy.

WEEKEND ASSIGNMENT

1. Which of the following is a factor that affects supply of money? (a) citizens (b) bank rate (c) level of education (d) level of literacy.
2. Liquidity preference in the concept of demand for money is the same as ____ (a) velocity of money (b) supply of money (c) desire to hold money in cash (d) value of money
3. The quantity theory of money was propounded by an American Economist known as ____ (a) Sir Donald Cameron (b) Adam Smith (c) Sir Irving Fisher (d) David Richardo
4. The determinant of the value of money include all the following factors except…….. (a) price index (b) general price level (c) supply of money (d) volume of goods and services produced
5. The statistical measure designed to show changes in variable or group of related variables with respect to geographical location or other features such as income, profession, population, etc, is known as………. (a) a relative price level (b) an index number (c) a liquidity ratio (d) an accelerated principle

THEORY

1. What is quantity theory of money?

State five factors that determine the supply of money