It is the interaction of this need with the functions of the good or Equities are defined as a claim to a time stream of payments that are fixed in real units. It can refer to the demand for money narrowly defined as M1 (directly spendable holdings), or for money in the broader sense of M2 or M3. Suppose an individual receives Rs.1200 as income on the first of every month and spends it evenly over the month. Another variable is trading in existing capital goods by ultimate wealth holders. It refers to people’s preference for holding assets in liquid form at a given rate of interest. Another weakness of the quantity theory of money is that it concentrates on the supply of money and assumes the demand for money to be constant. Individuals hold some cash to provide for illness, accidents, unemployment and other unforeseen contingencies. Tobins’ risk aversion theory of portfolio selection is superior to the Keynesian liquidity preference theory of speculative demand for money on the following counts: First, Tobin’s theory does not depend on inelasticity of expectations of future interest rates, but proceeds from the assumption that the expected value of capital gain or loss from holding interest-bearing assets is always zero. Medium of exchange 2. Tobin starts his portfolio selection model of liquidity preference with this presumption that an individual asset holder has a portfolio of money and bonds. 4. Explain how the following events will affect the demand for money according to the portfolio theories of money demand: a.The economy experiences a business cycle contraction. The precautionary motive relates to “the desire to provide for contingencies requiring sudden expenditures and for unforeseen opportunities of advantageous purchases.” Both individuals and businessmen keep cash in reserve to meet unexpected needs. Discover everything Scribd has to offer, including books and audiobooks from major publishers. The Division of Wealth between Human and Non-Human Forms: The major source of wealth is the productive capacity of human beings which is human wealth. This can be done by using current earnings to purchase non-human wealth or by using non-human wealth to finance the acquisition of skills. Nonetheless, with the cost per purchase and sale given, there is clearly some rate of interest at which it becomes profitable to switch what otherwise would be transactions balances into interest-bearing securities, even if the period for which these funds may be spared from transactions needs is measured only in weeks. It is the interaction of this need with the functions of the good or This demand for money curve relates to the speculative demand for money and not to the aggregate demand for money. The demand for money theory will be the chief component associated with the pecuniary economic sciences theory and an indispensable section in the macroeconomic theory. With a further fall in the interest rate to r6, it rises to OS1 But at a very low rate of interest r2, the Ls curve becomes perfectly elastic. Hence, not in the case of M1 = CC + DD, which earn either zero or very low interest rates. According to him, money is held for a variety of different purposes which determine the total volume of assets held such as money, physical assets, total wealth, human wealth, and general preferences, tastes and anticipations. It also yields real return in the form of convenience, security, etc. The curve shows that when the rate of interest falls from a higher level, there is a smaller increase in the demand for money. The Keynesian Approach Liquidity Preference 3. 2. The theories are: (1) Fisher’s Transactions Approach, (2) Keynes’ Theory, (3) Tobin Portfolio Approach, (4) Boumol’s Inventory Approach, and (5) Friedman’s Theory. Besides liquidity, variables are the tastes and preferences of wealth holders. It shows how the money demand function fits into static and dynamic macroeconomic analyses and discusses the problem of the definition (aggregation) of money. If g is the expected capital gain or loss, it is assumed that the investor bases his actions on his estimate of its probability distribution. 1. LESSON 13: Although money neither brings any return nor any risk, yet it is the most liquid form of assets which can be used for buying bonds any time. This is known as the liquidity trap when people prefer to keep money in cash rather than invest in bonds and the speculative demand for money is infinitely elastic. Thus point E on this line drawn as perpendicular from point T determines the portfolio mix of money and bonds. But the majority of investors belong to the third category. The demand for money on the part of wealth holders is a function of many variables. Third, there is also the difference between the monetary mechanisms of Keynes and Friedman as to how changes in the quantity of money affect economic activity. Image Guidelines 4. III. At r2 interest rate, the total demand for money curve also becomes perfectly elastic, showing the position of liquidity trap. Each form of wealth has a unique characteristic of its own and a different yield. They emphasized the transactions demand for money in terms of the velocity of circulation of money. 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