Demand for Money: Transaction Approach

Demand for Money: Transaction Approach

Importance

  • Demand for money determines the rate of interest, prices, and national income of the economy.

Key Figures

  • Irving Fisher: Introduced the purchasing power of money in 1911.
  • Fisher focused on money as a medium of exchange for buying goods and services.
  • J.M. Keynes: Stressed the store of value function of money.

Function of Money

  • Money serves as a means of payment for transactions involving goods, services, raw materials, and assets.

Assumptions of Theory

  • Say's Law of Demand: The sum of the values of all goods produced equals the sum of the values of all goods bought.
  • Full employment follows from Say’s Law.

Transaction Demand

  • Equation of Exchange: MV=PTMV = PT
    • MM = the quantity of money in circulation
    • VV = transactions velocity of circulation
    • PP = average price
    • TT = the total number of transactions
  • Converting the identity into the theory of demand for money: M<em>s=M</em>dM<em>s = M</em>d

Value of Money and Price Level Relationship

  • P=f(M)P = f(M)
  • 1/P=f(M)1/P = f(M)
  • The relationship between money supply (M) and price level (P) is direct.
  • The relationship between the value of money (1/P1/P) and money supply (M) is inverse.

Factors Affecting Demand for Money (Fisher’s Approach)

  • Number of transactions (T)
  • Average price of transactions (P)
  • Transaction velocity of circulation of money (V)