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CHAPTER 7 - The Demand For Money, Fisher's - DIFFERENCES - Cambridge,…
CHAPTER 7 - The Demand For Money
Fisher's Quantity Theory of Money
QuantityTheory of money demand
Conclusion, People hold money only to conduct transactions and have no freedom to choose the amount of money they wish to hold
From the equation of exchange to the quantity theory of money
P x Y = M x V : Nominal income is determined solely by movements in the quantity of money.
Velocity of money and Equation of exchange
To examine the
link between the total quantity of money
M
, (money supply)
and
the total amount of spending on final goods and services produced on the economy,
P
Y*
Velocity is the
rate of turnover money
that is
average number of times per year that a RM is spend in purchasing goods and services.
V= P*Y / M
Equation of exchange ( nominal income = quantity of money multiplied by the velocity)
M
V = P
Y
Quantity Theory and Price Level - Movement in the price level results solely from the changes in the quantity of money
Cambridge Approach to Money Demand
Cambridge approach - individual hold money because of this both function of money.
1) medium of exchange : people hold money to carry out transaction
2) Store of wealth : The level of people's wealth also affects the demand for money. The Cambridge economists also believed that the wealth component of money demand is proportional to nominal income.
Md = k x PY according to Cambridge, interest rate (k) could fluactuate in the short run because decisions about using money to store wealth would depend on the yields expected return on other assets that also function as store of wealth.
Keynesian Liquidity Preference Theory
Keynes - abandoned the quantity theory view that velocity was a constant
Demand for money - liquidity preference theory
3 Motives
Precautionary Motive (Mdp)
People hold money as a cushion against an unexpected need
Interest rate does not have any influence on the demand for money
Diagram
Speculative Motive (Mds)
Money is a store of wealth & called this reason for holding money the speculative motive
Interest rate is determined by the intersection of the money supply and demand curve
Diagram
Transactions Motive
Individuals holds money because it is a medium of exchang
Interest rate does not have any influence on the demand for money
Diagram
Md = Mdt + Mdp + Mds
Friedman's Modern Quantity Theory of Money
People want to hold a certain amount of real money balances
Md have positive relationship with the permanent income which is its more stable rather than current income (price fluctuate)
Md have negative relationship with the relative asset rate of return. Increase or decrease he money demand rate depending on other assets return.
Fisher's - DIFFERENCES - Cambridge
k is not necessarily stable
Did not rule out the effects of interest rate
Submerged the demand for money in the velocity concept
C - Emphasized individual choice
k is stable
Rule out any possible effects of interest rate on the demand for money in the short term
Emphasized the demand for money
F - Emphasized technology factors
Friedman - DIFFERENT - Keynesian
Lumped financial assets other than money into big category ( bonds)
Interest rate are an important determinant of the demand for money
Concept - Measured income (real)
Interest rate should have little effect on the demand for money
Include many assets as alternative to money
Concept - permanent income
SIMILARITIES - Keynes & Friedman
Each theory pursued the question of why people choose to hold money and analyses specific motives for holding money
Friedman's theory use similar approach to that keynes
Pro cyclical movements of velocity are predictable and yielding a quantity theory that money is primary determinant of aggregate spending
Each theory recognized that people want to hold a certain amount of real money balances
SIMILARITIES
Both approaches developed a classical approach to the Md
Both models is use the same equation but different interpretation in terms of the k