DEMAND FOR MONEY - LIQUIDITY PREFERENCE TRANSACTIONS DEMAND - this is money used for the purchase of goods and

services. The transactions demand for money is positively related to real incomes and inflation. As an individual's income rises or as prices in the shops increase, he will have to hold more cash to carry out his everyday transactions. The quantity of nominal money demand is therefore proportional to the price level in the economy. (note: the real demand for money is independent of the price level) PRECAUTIONARY BALANCES - This is money held to cover unexpected items of expenditure. As with the transactions demand for money, it is positively correlated with real incomes and inflation. SPECULATIVE BALANCES The speculative (or asset or liquidity preference) demand for money is for securing profit from knowing better than the market what the future will bring forth". Individuals and' businessmen having funds, after keeping enough for transactions and precautionary purposes, like to make a speculative gain by investing in bonds. This is money not held for transaction purposes but in place of other financial assets, usually because they are expected to fall in price. There is an inverse relationship between interest rates and the market prices of fixed interest government securities Keynes argued that each individual has a view about an 'average' rate of interest. If the current interest rate was above the average rate then a rational individual would expect interest rates to fall. Similarly, if current rates are below the average rate then obviously interest rates would be expected to rise. At high rates of interest, individuals expect bond prices to rise and interest rates to fall. To benefit from the rise in bond prices individuals use their speculative balances to buy bonds. Thus when interest rates are high speculative money balances are low. At low rates of interest, individuals expect bond prices to fall and interest rates to rise. To avoid the capital losses associated with a fall in the price of bonds individuals will sell their bonds and add to their speculative cash balances. Thus, when interest rates are low speculative money balances will be high. There is an inverse relationship between the rate of interest and the speculative demand for money. The total demand for money is obtained by summating the transactions, precautionary and speculative demands. Represented graphically, it is sometimes called the liquidity preference curve and is inversely related to the rate of interest.

THE DEMAND FOR MONEY AND THE RATE OF INTEREST

MONEY DEMAND AND INCREASES IN REAL GDP Consider a period of sustained economic growth in the economy. Rising real incomes and increasing numbers of people employed will increase the demand for money at each rate of interest. Therefore higher real national income causes an outward shift in the demand for money. This is shown in the diagram below

FINANCIAL INNOVATION AND THE DEMAND FOR MONEY The pace of change in financial markets is rapid and this affects our demand for money balances in order to finance our purchases. In recent years the demand for cash balances (M0) has declined relative to the demand for interest-bearing deposit accounts. Most people can finance their purchases using debit cards and credit cards rather than carrying around large amounts of cash. Financial innovation has reduced the demand for cash balances at each rate of interest represented by an inward shift in the money demand curve.

Components of Money= M1+M2+M3 Where, M1= total money in circulation+ total demand deposits in bank M2= M1+ Post Office savings M3= M2+ total time deposits