Explain: (a) (i) supply of money (ii) Value of money (b) highlight the three motives for holding money.

Answer Details

(a)(i) Supply of money. The supply of money is the total stock of money in circulation in an economy at a given point in time. It is made up of currency (notes and coins) held by the public plus demand (current-account) deposits held with the commercial banks that are available for spending.

(a)(ii) Value of money. The value of money is the purchasing power of money, that is, the quantity of goods and services that a unit of money can buy at a given time. It varies inversely with the general price level: when prices rise (inflation), the value of money falls; when prices fall (deflation), the value of money rises.

(b) Three motives for holding money (Keynes's liquidity preference).

1. Transactions motive. Money is held to meet day-to-day spending on goods and services between the receipt of one income and the next.
2. Precautionary motive. Money is held as a reserve to meet unforeseen or emergency expenses such as illness, accidents, or sudden needs.
3. Speculative motive. Money is held to take advantage of future changes in the prices of bonds and other assets, that is, to buy assets when their prices are expected to fall (interest rates to rise) and profit from the movement.