a. What is money? b. Explain the following concepts: i. value of money: ii. demand for money, (c) ldentify any four determinants of transaction demand for m...

Answer Details

(a) Money. Money is anything that is generally acceptable as a means of payment for goods and services and in the settlement of debts. Its main functions are to serve as a medium of exchange, a measure (unit) of value, a store of value, and a standard for deferred payments.

(b) Concepts.

• (i) Value of money. The value of money is its purchasing power, that is, the quantity of goods and services a unit of money can buy. It varies inversely with the general price level: when prices rise (inflation) the value of money falls, and when prices fall the value of money rises. \[ \text{Value of money} \propto \frac{1}{\text{Price level}} \]
• (ii) Demand for money. The demand for money (liquidity preference) is the desire to hold wealth in cash or liquid form rather than in other assets. Following Keynes, money is demanded for three motives: the transactions motive (day-to-day spending), the precautionary motive (unforeseen needs), and the speculative motive (to take advantage of changes in interest rates or asset prices).

(c) Four determinants of the transactions demand for money.

• Level of income. The higher a person's or nation's income, the more cash is held for spending.
• The price level. Higher prices require more money to buy the same goods.
• Frequency (interval) of income payment. People paid weekly hold less than those paid monthly, other things equal.
• The general standard of living / spending habits. Higher consumption needs raise the cash held for transactions.
• The value of transactions a person expects to carry out over the period.

Examination takeaway. Keep the two ideas distinct: the value of money is about what money can buy (inverse of prices), while the demand for money is about why people choose to hold cash; the transactions motive in particular depends mainly on income and the price level.