Their respective transactions motives may be referred to as income motive and business motive. Thus, when the rate of interest is expected to rise, people prefer to hold more money balances at the current rate of interest so that they can take advantage of a rise in the interest rate in future and earn more. 600. Before publishing your Article on this site, please read the following pages: 1. It follows, therefore, that the amount of money balances held under the transactions motive will depend: (i) on the time and size of firms’ incomes, and (ii) on the turnover of business. John Maynard Keynescreated the Liquidity Preference Theory in to explain the role of the interest rate by the supply and demand for money. Ch 1 總體經濟學導論. the keynesian demand function for money: some statistical tests † Dennis R. Starleaf Richard Reimer acknowledges support from the National Science Foundation. ADVERTISEMENTS: Let us make an in-depth study of the Keynesian Theory of Investment. This desire for money is described by Keynes as liquidity preference. Briefly, therefore, the speculative demand for money is a function of the rate of interest. The following article will guide you about how Keynesian theory of money differs from the quantity theory. Copyright. The Demand for Money: The Classical and the Keynesian Approach Towards Money Article shared by Read this article to learn about the demand for money: the classical and the Keynesian approach towards money: The demand for money arises from two important functions of money. It is also referred as liquidity preference. The precautionary demand for money is the demand for cash by the public for contingencies, which may involve unexpected expenditures and opportunities. Idle Cash Balances (The Speculative Demand for Money): Keynes pointed out that a section of people in the community hold cash balances for speculative purposes. According to Keynes investment decisions are taken by comparing the marginal efficiency of capital (MEC) or the yield with the real rate […] Therefore, when uncertainty is present, people tend to hold money balances to act as a buffer against unforeseen contingencies. Flag for Inappropriate Content. The precautionary demand for money depends largely on the uncertainty of future receipts and expenditures. Businessmen require money balances in order to meet business expenses like payment for new materials and transport, payment of wages and salaries, and allied current expenditure. 60 by the interest on bond exactly 10 per cent of the purchase price. 1,000 in government bonds, yielding 6 per cent annual interest and that, at that time, the market rate of interest was 6 per cent. Working off-campus? In symbolic terms, by denoting the precautionary demand for money as Lp, we can represent the money- demand function as follows: In practice, however, it is difficult to bifurcate the transactions demand and the precautionary demand for money. Now, suppose the market rate of interest increases to 10 per cent. Graphical illustration of the Keynesian theory. It is, thus, sometimes called as liquidity proper. The monetarist revival of the quantity theory The Keynesian revolution overwhelmed the traditional quantity theory and for a long time its acceptance was so complete that it was above challenge. Thus, the demand for money, in the Keynesian sense, is a demand for liquidity or “liquidity preference.” Hence the modern approach to the demand for money has been designated as the cash balance or liquidity preference approach. Content Guidelines Money held for transactions and precautionary motives depends upon the level of income. Money held under the speculative motive constitutes a store of value, a liquid asset, which the holder intends to use for gambling or to make a speculative gain, e.g., investment in securities at a opportune moment. Keynes recognized that ‘money held for each of these three purposes forms, nevertheless, a single pool, which the holder is under no necessity to segregate into three watertight compartments’ (ibid., p. 195); however, he did suggest that these three categories formed an exhaustive set and that all other reasons for holding money (e.g. The Keynesian emphasis on compartmentalizing the demand for money into active and idle components resulted in a mechanical interpretation of velocity and the associated view that money does not matter. A spendthrift obviously needs more transactions demand for money than a saver does. Keynes is considered to be the greatest economist of the 20 th century. Nevertheless, the trend of a community’s aggregate demand for money, under the transactions motive, depicts a high degree of correlation of proportionality to the size of money of national income. An obvious answer is provided by the subjective considerations of individuals regarding liquidity motives for the satisfaction of which they desire to hold money balances. These are: (1) the transactions motive; (2) the precautionary motive, and (3) the speculative motive. The reason for this inverse relationship lies in the fact that securities prices (and also of all capital values) actually are the present (capitalised) value of the future flow of income, discounted at the market rate of interest for the type of investment involved. The money balances which people hold under the precautionary motive will be devoted to fulfilling the function of a store of value. Effective demand and quantity of money change in the same proportion so long as there are any unemployed resources. 2. In contrast to the Fisherian view of what people ‘have to hold’, the Keynesian view stated that the demand for money is determined by what people ‘want to hold’. Now, suppose an investor has invested Rs. And, it must be remembered that both are income-determined. At higher income level OY 2 , it becomes OB. The purpose of holding money under the speculative motive is to use it for speculation for earning income. 1,000 for it. PKE rejects the methodological individualism that underlies much of mainstream economics. This means that the investor earns Rs. Since L t = f(Y), and L p = f(Y), it follows that L 1 = f(Y), that is to say, the demand for active balances is a function of income. Learn more. It has been observed that at low rates of interest, people prefer to hoard their money rather than use it to buy securities and vice versa. 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