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Meaning of Money
Money takes many forms
Money is any asset which performs the functions of money.
Functions of money:
1. Medium of Exchange
2.Unit of account
3. A standard of Defered Payments
4. A store of value
Demand for money Theories
The amount of wealth that households and business desire to hold in the form of
It is the number of times an average rupee changes hands during a period of time.
produced and sold. The right hand side is the real flow of goods and
services, measured in money terms. The left hand side is the money
flow.
Cambridge approach:
M = k PQ = KY
Where, M,P and Q are defined as in the above equ
K = the fraction of Y or PQ that the community holds in the form of
money balances.
K is the reciprocal of V ie k = 1/V or V = 1/k
Md = Kpq = KY = Ms - Equilibrium
That means amount demanded is a proportion of PQ or Y or GNP.
Amount demanded is directly related to the spending involved in GNP.
Example
Suppose if GNP = Rs.27,000 crs
Velocity = 3
Then desired cash holdings will be 1/3 of GNP
Thus the amount demanded will be Rs.9,000 crs
Keynesian Approach:
According to classical approach money is demanded only for
level of income.
Speculative Demand for Money:
Speculative demand for money changes with the change in the
securities.
For instance, some intelligent individuals anticipated the
2000-03 stock market decline, and sold shares and went
liquid.
Rate of interest is the most important determinant in
the operations of money market.
It is related to the opportunity cost of holding money
Which means the interest foregone by not holding higher
interest bearing assets, such as bonds or shares.
Generally if interest rates rise, they rise more on bonds and
other securities than on bank accounts.
The demand for money will thus fall as people switch to these
alternative securities.
Therefore, the demand for money is inversely related to the
rate of interest.
Money supply
Money supply is not just cash, but deposits in banks and other
financial institutions.
People can access and use this money in their accounts through
cheques, debit cards, standing orders, direct debits etc. without the
need for cash.
Measures of Money: M1, M2, M3 & M4
Banks and the creation of credit:
Banks play an absolutely crucial role in the monetary system
Banks create additional money by increasing the amount of bank
deposits.
By lending to people-granting overdrafts or loans- these loans are
spent-shops deposit in their accounts, or have it directly transferred
when debit cards are swiped across their tills.
Thus the additional loans granted by banks become deposits in the
shops banks. These are further used as loans again . These in turn
create further deposits and so on. The process is known as the
creation of credit.