Table of Contents

Supply of money means volume of money held by the people of the country which includes individuals and business hours. It is the aggregate stock of domestic money held by the public.

Money supply is a stock concept. It measures the total amount of money available in an economy at a specific moment in time (e.g., as of December 31st). 

Demand for Money

Demand for money arises because money can be put to several uses. Demand for money doesn’t mean the amount of money people own to hold.

There are two distinct approaches to the concept of demand for money:

1. Classical Approach –

JS Mill, Fisher, David Hume and AC Pigou are the economist who popularised the classical approach to the concept of money. Money is only a medium of exchange and people demand money for transaction purposes. In their opinion demand for money arises because it helps in smooth transaction of goods and services.

2. Keynesian Approach –

It is a modern concept; also called as cash balance approach. J.M. Keynes popularised this concept in his book “The General Theory of Employment, Interest and Money”, published in 1936. According to Keynes, demand for money arises because people want to hold money or liquid for 3 main purposes: -

  1. Transaction Purposes – Money is the most important medium of exchange. Hence, people demand money as it is useful in carrying out trade, transaction and business activities in the country. The day to day transactions are influenced by the amount of ready cash available.

Demand for money depends on:

  1. Level of Income/Money - Higher income levels lead to higher consumption and, consequently, a higher demand for money to facilitate transactions.
  2. Periodic Interval at Which Income is Received - The longer the interval between receipts of income (e.g., getting paid monthly vs. daily), the more money individuals need to hold to bridge the gap between payments.
  3. Level of Business Activities - Increased business activity (higher turnover, more transactions) requires more cash to cover expenses like raw materials, wages, and transportation.
  4. Existing Method of Payment - Technological advancements (UPI, credit cards, banking) reduce the need to hold physical cash, thus lowering the demand for money for transactions. 

​​In summary, the demand for money is a function of income, the timing of receipts, business activity, and the efficiency of payment technologies.

  1. Precautionary Demand – It means that people like to hold money to meet certain unforeseen and unexpected expenditure. People like to take precautions against certain liquidity and unforeseen expenses like accidents, sickness, hospitalisation etc.

The precautionary demand for money depends on:

  1. Level of Income - Precautionary demand is directly related to income. Higher income enables individuals and firms to set aside more cash as a buffer.
  2. Desire for Future Security - It is driven by uncertainty, risk aversion, and the desire for safety against unexpected future expenses.
  3. Nature of Business Activities - Businesses with more volatile cash flows or higher risks require higher precautionary balances to handle unexpected unfavorable conditions.
  4. Availability of Credits - The easier it is to borrow (high availability of credit), the less need there is to hold cash, thus reducing precautionary demand.
  5. Rate of Interest Offered by Commercial Values - While Keynes argued it was mostly dependent on income, modern analysis indicates that a higher interest rate represents a higher opportunity cost of holding money, leading to a decrease in precautionary holdings.

In summary, precautionary demand increases with higher income and uncertainty (security needs) and decreases with higher interest rates and easier access to credit. 

  1. Spectacular Demand – It is the desire of the people to hold resources in liquid form to take advantage of market movements. It refers to the desire of people to hold cash in anticipation of earning profits in future. 

According to Keynes, “people hold cash anticipating future changes in prices.” This technique is commonly observed in stock exchange market.

The spectacular demand for money depends on:

  1. Rate of Interest - This is the most crucial factor. There is an inverse relationship between the speculative demand for money and the rate of interest. When interest rates are low, people expect them to rise (meaning bond prices will fall), so they hold more money (higher demand). Conversely, when interest rates are high, people expect them to fall, so they invest in bonds, reducing their speculative demand for money.
  2. Number of Spectaculars - The total speculative demand for money depends on the collective behavior of speculators in the market. A larger number of individuals seeking to make speculative gains will increase the overall demand for holding idle cash. 
  3. Stock Exchange Market / Bond Market - Speculative demand exists because people want to avoid potential capital losses in the stock or bond markets. If investors believe market conditions are risky, they will hold more money, thus increasing speculative demand.
  4. Investment Opportunity - Speculative demand is, by definition, holding money to take advantage of future, more profitable investment opportunities, such as purchasing bonds or stocks when their prices are low. 

Therefore, the speculative demand for money is a function of the rate of interest, expectations about future interest rate changes, and the overall desire to avoid capital losses in financial markets.