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Asset Demand For Money

Money has the distinctive feature fo being the only asset which is perfectly liquid. The only disadvantages of holding this type of asset is that it yields no income. If the owner of a money balance exchanges it for bonds, he will revise a return in the form of interest the purchase of shares will give him the prospect of dividends, while the acquisition of physical assets to be employed in production can bring him a flow of profits. Why should people then desire to hold money balances?

Determinants of Asset Deamand

Prof. Keynes systematically analyzed the motives for holding money and gave three motives for holding money:

1.    the transaction motive;
2.    the precautionary motive; and
3.    the speculative motive.

Transactions demand ( Mtd )

This demand reflects the need of cash for the current transactions of personal and business exchanges and is derived directly from the medium of exchange function of money. Keynes considered this to be largely determined by the level of income:

Mtd  = f(Y)

The other details along with diagrammatic representation have been given in the preceding section2 above.

Precautionary demand ( Mtd )

The precautionary demand for money arises out of the need for any contingent payments or expenditure. Individuals and firms alike desire to hold cash balances for covering events of a more uncertain nature, like accidents, prolonged illness or the loss of job or replacement of a machinery demand by an accident, etc. The are called precautionary balances. Like transactions motive, precautionary demand for money is also closely related to the level of income. Ay higher level of income, individuals and firms amy keep more cash individuals and firms may keep more cash, balances for meeting unforeseen situations. Thus, the precautionary demand for money is also a function of the level of income:

Mtd = g (Y)

Speculative demand ( Mtd )

In addition to functioning as a medium fo exchange, money also services as a store of value. It is this second function of money which gives rise to what it called the “asset demand for money”. This type of demand for money is due to what Keynes preferred to call speculative demand for money, which refers to the desire to hold money as an alternative to the financial assets, like bonds. Keynes considered only two types of assets: cash and bonds. People hold money in expectation of changes in interest rates or changes in the capital value of assets.

If people anticipate that the prices of bonds are likely to increase, because they are already law, then they would hurry up to buy bonds. If their anticipation proves correct, i.e., if they are able to read market trends correctly, they will make capital gains when price go up. The gain is made by purchasing low an selling high. Similarly, if they expected that bond price are likely to fall, as they might have reached too high now, the bond holders may like to move our of bonds to money by selling them off in order to ovoid future capital loss.

Thus, if bond prices are low, people prefer to move form money to bonds and if prices are high, they prefer to move from to money bodings.

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