At E, the demand and supply of high-powered money are m equilibrium and money supply is OM. In macroeconomics, the money supply (or money stock) is the total value of money available in an economy at a point of time. In old times, the coins formed the bulk of money supply of the country. Aims of the chapter. Control of the Money Supply. Thus, money supply means total volume of monetary media of exchange available to the community for use in connection with the economic activity of the country. Like many economic variables in a reasonably free-market economy, interest rates are determined by the forces of supply and demand. The transactions motive relates to the demand for money or the need for cash for the current transactions of individual and business exchanges. The supply of money in an economy needs to be monitored and controlled since an excess or deficiency in money supply can lead to serious negative impacts on the economy. Compare with it the position in 1950-51, when deposit money with the public was not even one-half of the currency in circulation among the public. more Monetary Aggregates Describes the … This is because as interest rates increase, the opportunity cost of holding money increases, and people will be better off by investing in other financial instruments than holding money. A certain amount of ready money, therefore, is kept in hand to make current payments. Legislation in the early 1980s allowed for money market deposit accounts (MMDAs), which are essentially interest-bearing savings accounts on which checks can be written. Real money demand and the real money supply as functions of the real interest rate are illustrated in the above graph. Share Your PPT File. The supply of money in an economy is controlled by its central bank, for example, Fed in the US. The businessmen and the entrepreneurs also have to keep a proportion of their resources in ready cash in order to meet current needs of various kinds. The money demand curve is downward sloping, i.e., the demand for holding money increases with decrease in interest rates. To satisfy this demand the government or the money issuing authority of a country or an economy must maintain a continuous supply of money. According to Keynes, the demand for money, or liquidity preference as he called it, means the demand for money to hold. The above discussion indicates that money demand will depend positively on the level of real GDP and the price level due to the demand for transactions. The actual value of the money supply chosen is M 0. ” The money supply measures are meant to reflect differing roles of money; MI measures money used as medium of exchange, while M2 measures money used as store of value. Demand and Supply Curve. Data regarding money supply is recorded and published because it affects the price level, inflation, the exchange rate, and the business cycle. The charts above show the two money supply aggregates. The flow is over a period of time and not at a given moment. This lesson is part 5 of 20 in the course. The demand for money is affected by several factors such as income levels, interest rates, price levels (inflation), and uncertainty. The money supply (MS) is vertical since it is assumed that there is a constant amount of money … It is clear that the amount of money held, under this business motive, will depend to a very large extent on the turnover (i.e., the volume of trade of the firm in question). Most of the people receive their incomes by the week or the month, while the expenditure goes on day by day. The supply of money is the quantity of money, currency and bank deposits, set by the Fed. The demand curve for money is downward sloping, indicating that when the value of money is low (and the price level is high), people demand a larger quantity of it to buy goods and services. Your email address will not be published. TOS4. The increased business activity raises the demand for labor. This means the households and firms are holding more money and they will purchase securities to lower their money balances. The Fed may change the money supply by using open market operations or by changing reserve requirements. If however, bond prices are expected to fall, i.e., the rate of interest is expected to rise, businessmen will sell bonds to avoid capital losses. Speculative: People also hold money for speculative purposes so that they can take advantage of investment opportunities in the future. This shows that the banking habit has steadily been growing in the country and the time will not be far off when deposit money will far outstrip the currency money. The demand for money can refer to narrow definitions of the money supply (M0, M1) or broad measures of the money supply like M3 or M4. Deposit money with the public in India consists of two items, viz., net demand deposits of bank and ‘other deposits’ with the Reserve Bank of India. It will be useful to have an idea of the demand for and the supply of money. Privacy Policy3. Money demand in a liquidity trap. At the equilibrium, shown in the figure as point A, the quantity of money demanded balances the quantity of money supplied. Thus, the supply of money in a country, by and large, depends on the credit control policies pursued by the banking system of the country. When the central bank wants to give a boost to the economy of the country, it follows a cheap money policy, lowers the bank rate, which is followed by lower rates of interest charged by the commercial banks, thus helping credit creation by the banks. Just like any other market demand and supply of money will interact to produce an equilibrium price of money. A somewhat broader measure of the supply of money is M2, which includes all of M1 plus savings and time deposits held at banks. Given the expectations about the changes in the rate of interest in future, less money will be held under the speculative motive at a higher current or prevailing rate of interest and more money will be held under this motive at a lower current rate of interest. The total amount of bank deposits in the country is determined by the monetary policy of the central bank of the country. Demand. The demand and supply curve for money can be represented as follows: It is, in fact, customary to call demand for money the demand for short-term loans and supply of money the supply of such loans. Precautionary: This is the money needed for uncertain future needs, for example, unexpected medical expenses. 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