Page 165 - DECO402_Macro Economics

Macroeconomic Theory

Notes y By determining its Cash reserve ratio (CRR), which is the base of credit multiplier, commercial
banks influence the supply of money.
y General public, by determing their preference for liquididty, influence the supply of money.
It determines the cash reserve ratio of commercial banks and their power to create credit.
Velocity of money should not be ignored. It means that how many times, one unit of money (like a
note or a coin) is used as a means of exchange. If velocity of money is measured in form of per unit
time-period or in form of flowing concept then, it will also be an important determinant of money
supply.

Ideal Supply of Money
Supply of money has an influence on net expenses. Consequently, trade activities, production and
employment, all are affected by this. The question arises that for purchasing products produced by
an economy will full employment, in which not source of
production is wasted, how much money is needed? this Students are advised that they read
supply of money itself is known as ideal supply. As a result this paragraph carefully so that they
of this supply, it becomes possible to completely utilize may have knowledge about how
the production capacity of the country. In a situation of supply of money affects the financial
full employment, if supply of money exceeds ideal supply, activities in an economy.
condition of inflation arises and prices will rise sharply.
As opposed to this, if supply of money is less than ideal supply then prices will start declining,
depression will be there and unemployment will be there all around. Hence supply of money should
be such so that in the country, all those goods which are being produced may be purchased so that
condition of inflation or deflation may not be created.
It must be kept in mind that influence of supply of money on total expense will only be there when
people will spend money and not keep it with themselves in form of cash. In reality, by change in
supply of money there is also a change in liquidity of the people. People keep their assets in form
of monetary, financial and actual fund with themselves. As a result of change in supply of money,
changes also happen in monetary assets of the people. If due to change in monetary assets people
will want to spend more money on actual assets like house, car, TV set etc, then total expense, and
along with it national income will increase. As opposed to this, if people will want to spend their
money on financial assets like shares, securities etc. then their prices will rise and rate of interest
will decline. Low rate of interest will encourage investment and national income will rise. But if
people will prefer to keep their increased monetary assets in liquid form, then there will be no
change in total expenditure and nor will the national income change. Hence only by change in
supply of money objective of price stability or full employment cannot be achieved. Calculating
people’s demand for money is equally important.

Key Points

y Money Supply: It shows the quantity ofmoney available in the economy for business. It is a
stock concept which is measured on a definite time.
y Components of Money Supply: (i) Currency (ii) Demand deposits.
y Monetary Aggregates used in India: According to old measures it is M , M , M and M .
1
2
3
4
According to new measures it is NM , NM , L , L and L .
2 3 1 2 3
y Factors Influencing Money Supply: (i) Size of monetary base (ii) Ratio of cash and demand
(iii) Velocity

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