Professional Documents
Culture Documents
Measurement &
Distribution of
National Income
Functions of Money
I – Primary Functions
II – Secondary Functions
Store of value: In this function people hold money for aiming
future. Since, money has high liquidity people like to store value in
terms of money.
(ii) Metallic Money: Metals like gold, silver, copper, etc. were
used as they could be easily handled and their quantity can be
easily ascertained. It is divided into two parts:
Further, the demand for money also depends upon velocity of circulation of
money.
I) CLASSICAL APPROACH
Md = PT
(Md) = The demand for money
(P)= Price level
(T) = volume of transactions over a period of time
But it does not explain fully why people hold money. It does not clarify
whether to include as money such items as time deposits or savings
deposits that are not immediately available to pay debts without first
being converted into currency.
DEMAND FOR MONEY
I) CLASSICAL APPROACH
B) Cambridge Approach :
Fisher's transactions approach emphasized the medium of
exchange function of money, the Cambridge cash-balance
approach is based on the store of value function of
money.
B) Cambridge Approach :
The Cambridge economists considered a number of factors
which tend to influence the demand for holding money. They
are as follows:
People tend to hold money for transactions motive.
B) Cambridge Approach :
The portion of cash is commonly represented as K, a
portion of nominal income the product of the price level and
real income (PY)
Thus,
Md = KPY
The value of K has been assumed to be stable in the sense
that the determinants of K don't change significantly in the
long run.
B) Cambridge Approach :
4. Hoarding, i.e., holding money above the minimum desired for transaction
purposes, is considered irrational because money in itself has no value.
The higher the interests rate the lower the amount of asset
demand for money. The total amount of money balances that
people wish to hold for all purposes is called Money Demand and
price level is assumed to be constant in Keynesian model.
Liquidity Trap:
According to Keynes, If the current rate of interest is very low,
people will believe that it is the minimum rate of interest and they
would all hold assets in money rather than bonds. Nobody would
buy bonds at this rate in order to avoid capital loss. Therefore, the
demand curve for money may be perfectly elastic at a certain low
interest rate. The perfectly elastic portion of the demand
curve for money is called the liquidity trap.
Liquidity Trap:
II) Keynesian Approach of demand for money
Criticisms
Keynes theory of interest has been criticized on the following grounds:
1. It has been pointed out that the rate of interest is not purely a monetary
phenomenon. Real forces like productivity of capital and saving by the
people also play an important role in the determination of the rate of
interest.
2. Liquidity preference is not the only factor governing the rate of interest.
3. The liquidity preference theory does not explain the existence of different
rates of interest prevailing in the market at the same time.
In the short run, the increase in money supply will lead to a change
partly in real income (i.e., real aggregate output or Y) and partly in the
price level (P).
But, in the long run, the increase in money supply will be reflected in
the rise in price level.
MONEY SUPPLY
From April 1968, the RBI also started publishing another measure of the
money supply which it called Aggregate Monetary Resources (AMR). But
since April 1977, the RBI has been publishing data on four
alternative measures of money supply (M1, M2, M3 and M4) have
been evolved.
M2
Determinants of Money Supply
1. The Required Reserve Ratio: Under this two important ratio
are considered. They are:
H = C + R + OD.
Determinants of Money Supply
6. Money Multiplier:
Money multiplier (m) has positive influence upon the money
supply. An increase in the size of m will increase the money supply
and vice versa.
7. Other Factors:
It is also get affected by:
Interest rates.
Income of the Citizen.
Changes in business activity.
The Quantity Theory of Money
Fisher’s Equation of Exchange
This theory explain the causes that determine the exchange value
of or general level of prices.
MV = PT
P= MV /T
Due to the criticism, Fisher extended the original equation of
exchange and incorporate the equation with volume of bank
deposits or bank money (M’) and it’s velocity of circulation
(V’).
So, now equation is
MV + M’V’= PT
&
P= MV + M’V’/T
Unrealistic Assumptions
Price Level may be Active factor.
Process of Price Level change is not explained properly.
Theory has limited application.
Fisher’s ignored Non- Monetary Factors like: economic
policies.
Hoarded Money is not included.
Time lag between the money supply and affect on price
level.
P & T are no explained properly. (P=Wholesale price or
retail price and T= Transaction include consumer goods and
capital goods)