MacroeconomicsI_working_version (1)

62
Chapter 7
However such assets are not money because they don’t serve as a mediums of
exchange or units of account due to their low liquidity.
7.5. Demand for Money
Before we start examining the demand for money we must make a clear distinction among
money as the most liquid asset (including cash, checking accounts and closely related
assets) and the other less liquid assets bearing interest such as bonds. The demand for
money describes wants of people to held money instead of other assets bearing higher
interest yield. To explain the demand for money, we must ask why people want to hold
money. In general, there are two reasons for holding money: to make purchases with
money and keep money as an asset.
7.5.1. Transaction Demand for Money
Money serves as a medium of exchange, which makes it convenient for purchasing goods,
services or resources. Households hold money to pay for their daily needs – to buy food,
clothes, pay for services. Firms must hold enough money to pay for all resources engaged
in production process (such as labour, power, materials etc.). All these purchases for
holding money forms the transaction demand for money.
Figure 7.1 describes the transaction demand for money as a relation between the total
amount of money demanded (M) and the interest rate (i). The vertical curve depicts the
independence of transaction demand for money on the interest rate. The basic determinant
of the transaction demand for money is nominal GDP. The amount of money demanded
for transactions varies directly with the level of nominal GDP, because the larger
nominal GDP implies larger money value of goods and services exchanged in the
economy. Accordingly, the larger amount of money is needed to deal with these
transactions. Rising nominal GDP shifts the curve of the transaction demand for money to
the right.
i
D t
M
Figure 7.1 Transaction demand for money. Vertical curve of transaction demand for money reflect its
independence on interest rates. It shifts with changes in nominal GDP.