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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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