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24 February, 2016 - 16:12

Demand for money stems from the need to enter into transactions. In addition, there is an asset demand for money: for precautionary and for speculative reasons. The transactions demand for money is not interest rate sensitive. The asset demand for money is inversely related to the interest rate because money does not earn any return (and loses purchasing power with inflation): thus a smaller quantity would be held if the interest foregone is large. Demand for money is shown graphically as a downsloping curve.

Figure 10.1 Demand for Money

While the purpose of holding money is to be able to buy something, it is also common to hold some amount of money as money just in case it is needed. Such need may arise out of an unexpected accident or unforeseen bargain opportunity, both of which require the ability to make immediate payments. This is also true when going out of the house: it is unwise not to have a few dollars for emergency.