Q. Consider the following statements regarding demand for money:
1.A rise in income will lead to rise in demand for money.
2.Higher the interest rate, higher the demand for money.
Which of the statements given above is/are correct?
Explanation: The demand for money tells us what makes people desire a certain amount of money.
- Since money is required to conduct transactions, the value of transactions will determine the money people will want to keep: the larger is the quantum of transactions to be made, the larger is the quantity of money demanded.
- Since the quantum of transactions to be made depends on income, it should be clear that a rise in income will lead to rise in demand for money.
- Also, when people keep their savings in the form of money rather than putting it in a bank which gives them interest, how much money people keep also depends on rate of interest.
- Specifically, when interest rates go up, people become less interested in holding money since holding money amounts to holding less of interest-earning deposits, and thus less interest received.
- Therefore, at higher interest rates, money demanded comes down.
Source: TMH – Ramesh Singh