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This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. In the end, the classical theory of demand for money may be summarised as under: (ii) The ratio of desired money balances to nominal income is assumed to be constant at its minimum, or, in other words, velocity of money is constant at its maximum (because K = 1/V). Money helps to buy goods and services. Sayâs law states that, âSupply creates its own demand.â This means that the sum of values of all goods produced is equivalent to the sum of values of all goods bought. The Classical Approach: The classical economists did not explicitly formulate demand for money â¦ 4. They argued that money is not demanded for its own sake, that is, not for its store value. Privacy Policy Money is generally acceptable in exchange for goods and services and thus holding of money avoids the inconveniences of barter transactions. The fundamental principle of the classical theory is that the economy is selfâregulating. 5.1.1 Quantity theory of money Ch 5âClassical Theory â¢ The equation of exchange essentially states that the nominal money balances in the economy must equal the value of the goods and services which it is used to purchase Key assumptions â¢ V is taken as exogenous, being determined by various institutional features of the economy, 10. Fig. In due course of time, when bond prices go up, the holders sell them off striking capital gains. nominal value of the commodities that will be purchased during the week. 7.5). The equation of the cash balance approach is: M = PKT â¦ where M is the money supply, P is the price level, T is the total volume of transactions and K is the demand for money that people want to hold as a cash balance. Keynes, in his General Theory of Employment, Interest and Money, stressed on the store value function of money, while accounting for its demand. With wealth constant, an increase in demand for money means a decrease in the demand for bonds, y ââ m d â â b d â, by the budget constraint (4). (iv)Hoarding, i.e., holding money above the minimum desired for transaction purposes, is considered irrational because money in itself has no value. Keynes expounded his theory of demand for money. They argued that money is not demanded for its own sake, that is, not for its store value. Essay on Leadership: Introduction, Functions, Types, Features and Importance. In Fisher’s equation, PT = MV, the demand for money (Md) is the product of the volume of transactions over a period of time (T) and the price level (P). By the time the rate of interest falls to 10%, the market price of the bond rises to Rs 10,000, the highest under the assumption of the interest cycle with 10% as the lowest and 25% as the highest. â¢ KEYNESIAN THEORY OF DEMAND FOR MONEY â¢ Also known as âLiquidity Preference Theoryâ it is an extension of the cash balance theory of Cambridge. 7.4 (a) and (6)]. Money, in their view, was simply gold, silver and other precious metals. Transaction demand for money varies directly with income [Fig. Another weakness of the quantity theory of money is that it concentrates on the supply of money and assumes the demand for money to be constant. In the State of Equilibrium. (iii) Given the transactions and precautionary motives for holding money, the amount of money which an individual will choose to hold depends upon income and wealth forming the budget constraints for the individual. Our mission is to provide an online platform to help students to discuss anything and everything about Essay. The curve in the figure correlates the rate of interest to the demand for liquidity and is called the liquidity preference curve. At this point (point A in the figure), bond preference is the maximum and the liquidity preference, the minimum. That is, when rate of interest is the same as the rate of dividend, present value of the perpetual income stream is Rs 10,000. Classical Monetary Theory I We have now de ned what money is and how the supply of money is set I What determines the demand for money? Before proceeding any further with the derivation of total demand for money, let us first understand its three components discussed above in a little more detail.