Chapter15: Monetary Policy
Section: Chapter Questions
Problem 4QP
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Question
Explain what determines the demand for money.
Expert Solution
Step 1
The key determinants of the demand (DD) for money are income and the interest rate.
The Demand (DD) for money can be written as:
L=kY - hi
Where
L is the demand for real balances
k is the responsiveness of money to income.
h is the responsiveness of money to real interest rate
I is the real interest rate.
Now, as the equation suggests, the Demand for money has a positive relation with income. It is so because people hold money in order to pay for their purchases, which in turn depends on their income. So higher the level of income, higher is the demand (DD) for money.
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