Chapter 19
The Demand
for Money
PowerPoint Presentation by Charlie Cook
Copyright © 2004 South-Western. All rights reserved.
Fundamental Issues
1. What is the Cambridge equation?
2. What are real money balances?
3. According to the inventory theory of the
demand for money, what are the key factors
influencing desired holdings of real money
balances?
4. What do other transactions-related theories
add to our understanding of the demand for
money?
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19–2
Fundamental Issues (cont’d)
5. What theories explain the demand for real
money balances based on money’s function
as a store of value?
6. What difficulties do economists face in
trying to predict the overall demand for
money?
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19–3
The Motives for Holding Money
• Transactions motive:
 The desire to hold currency and transactions
deposits to use as media of exchange in planned
transactions.
• Portfolio motive:
 The desire to hold money as part of a strategy of
balancing the expected rate of return on money
with rates of return on other assets.
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19–4
The Demand for Money as a Medium of
Exchange
• The Cambridge equation:
 People use money assets to buy other goods and
services, their demand for such assets as media of
exchange depends on how many purchases they
plan to make. This depends on their ability to
spend, which in turn depends on their incomes.
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19–5
The Demand for Real Money Balances
• Real money balances:
 The purchasing power of the quantity of money in
circulation, measured as the nominal quantity of
money divided by an index measure of the prices
of goods and services.
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19–6
The Inventory Approach to the Demand
for Money
• Inventory theory of money demand:
 A theory of the demand for money that focuses on
how people determine the best inventory of money
to keep on hand.
 Assumptions:
On-hand money bears no interest.
 People earn a fixed amount of real income.
 People buy goods and services at a constant rate.

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19–7
An Annual
Spending Pattern
with a Constant
Rate of Spending
Figure 19–1
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19–8
Alternative Spending Patterns
Figure 19–2
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19–9
The Total Cost of Maintaining a Cash Inventory
Figure 19–3
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19–10
Factors Influencing the Cost-Minimizing Number of
Cash Conversions
Figure 19–4
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19–11
Factors Affecting the Amount of Real
Money Balances
• Real income:
 A rise in real income causes an increase in the
quantity money demanded.
• The interest rate:
 An increase in the bond interest rate induces a
reduction in the quantity of money demanded.
• The cash-conversion fee:
 An increase in the cash-conversion fee causes an
increase in the quantity of money demanded.
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19–12
Alternative Transaction-Based Theories
of Money Demand
• Shopping-time theory of money demand:
 A theory of the demand for money that focuses on
money’s role in helping people reduce the amount
of time they spend shopping, thereby freeing up
more time for leisure or work.
• Cash-in-advance approach:
 A theory of the demand for money based on the
assumption that people must have real money
balances in their possession before they can
purchase any goods or services.
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19–13
The Portfolio Demand for Money
• The Keynesian portfolio demand for money:
 Money, bonds, and financial wealth
 The speculative motive
Interest rate expectations
 Money demand and interest rates

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19–14
Money as a Social Store of Value
• The Overlapping-Generations approach to the
demand for money:
 A theory of money demand that emphasizes how
societies use money as a way to store and transfer
wealth across time.
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19–15
A Basic Overlapping-Generations Economy
Figure 19–5
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19–16
A Money Demand Schedule
Figure 19–6
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19–17
The Identification and Simultaneity
Problems
• Identification problem:
 The problem that economists face in evaluating
whether real-world data are consistent with the
downward-sloping money demand schedule that
money demand theories predict, given the fact that
both money demand and money supply vary over
time.
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19–18
The Identification and Simultaneity
Problems (cont’d)
• Simultaneity problem:
 The problem of accounting for the possibility that
factors influencing the quantity of money
demanded are themselves affected by how many
real money balances people hold, which can
complicate assessments of how well real-world
observations square with theories of money
demand.
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19–19
The Identification
Problem
Figure19–7
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19–20
Estimated Income
Elasticities of
Money Demand
SOURCE: Subramanian Sriram,“A Survey of Empirical Money
Demand Studies,” IMF Staff Papers 47 (3,2000): 334–365.
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Figure 19–9
19–21