Page 147 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes a fall in the price of the consumer good usually follows a fall in the price of the precedent
capital goods. Thus, entrepreneurs who correctly predict changes in preference will be
able to avoid the worst part of a fall in demand.
Even if a rise in the demand for money does not lead to the catastrophic consequences
envisioned by some monetary disequilibrium theorists, can an injection of fiduciary media
make possible the complete avoidance of these price adjustments? This is, after all, the
idea behind monetary growth in response to an increase in demand for money. Theoretically,
maintaining monetary equilibrium will lead to a stabilization of the price level.

This view, however, is the result of an overly aggregated analysis of prices. It ignores the
microeconomic price movements which will occur with or without further monetary
injections. Money is a medium of exchange, and as a result it targets specific goods. An
increase in the demand for money will withdraw currency from this bidding process of
the present, reducing the prices of the goods which it would have otherwise been bid
against. Newly injected fiduciary media, maintaining monetary equilibrium, is being
granted to completely different individuals (through the loanable funds market). This
means that the businesses originally affected by an increase in the demand for money will
still suffer from falling prices, while other businesses may see a rise in the price of their
goods. It is only in a superfluous sense that there is “price stability”, because individual
prices are still undergoing the changes they would have otherwise gone.

So, even if the price movements caused by changes in the demand for money were
disruptive — and we have established that they are not — the fact remains that monetary
injections in response to these changes in demand are insufficient for the maintenance of
price stability.

Question:
How do businesses affect the demand for money?

Source: www.cobdencentre.org
8.3.2 Motives for Holding Money

The two main motives for holding money are: the transaction motive and the speculative
motive.

The Transactions Motive

People hold money to buy things. This is transaction motive. How much money do people hold
with this motive? It depends upon two factors: the rate of interest and the cost involved in
buying and selling of bonds. The relevance of these factors is explained below and is subject to
some assumptions.
The assumptions are: (a) Money has only two uses: to hold or to buy bounds. (b) There is
non–synchronization of money and spending. It means that there is a mismatch between the
timing of money inflow and the timing of money outflow. It is because income arrives once a
month while the spending occurs at a uniform rate throughout the month. (c) The entire income
received at the beginning of the month is spent during the month.

The Optimal Choice

A person receives income at the beginning of the month. He has two options: to keep the entire
income as cash or to buy bonds. If he chooses the second option he earns interest. If he chooses

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