What Determines The Demand For Real Money Balances Without
What Determines The Demand For Real Money Balances Equation
How To Calculate Real Money Demand
What Determines The Demand For Real Money Balances Within

Let us make an in-depth study of the LM Curve:- 1. Subject-Matter of the LM Curve 2. The Slope and Position of the LM Curve.

Subject-Matter of the LM Curve:

For instance, a fall in the price level will increase the real value of cash balances held by the people. So when there is excess demand for money, the demand for goods and services is reduced. In this case, the real balance effect will not cause a proportionate but non-proportionate change in the demand for money. Thus the elasticity of demand. What determines the demand for real money balances and why? If there is an excess demand or supply for real money balances, how does the nominal interest rate change to correct the problem? We studied The Baumol-Tobin Theory of Money Demand. How is money demand determined in this model? Be able to use the model to analyze the effect of a change. Broadly speaking, the demand for money is thought to depend on three major factors: (a) total wealth to be held in various forms of assets; (b) relative price of and return on one form of wealth as compared to the other forms; and (c) tastes and preferences of the wealth-holders. Cost of holding cash balances is influenced by (a) the rate of.

The demand for real money balances is found simply by adding together the transactions demand for money and the asset demand for money.

As the transactions demand for real money balances is an increasing function of real income, the total demand for real money balances can be shown as a function of the real rate of interest that shifts to the right as real income is increased. This is shown in figure 14.3 (a). As real income increases from Y₁ to Y₂, the demand for real money balances shifts from LPY₁ to LPY₂ and so on as income increases in real terms through Y₃ and Y₄.

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Suppose that the economy is initially in an equilibrium position with real income as K₃ and the real interest rate at r₃. This equilibrium position for the money market is shown in Figure 14.3 (a). If conditions in the product market change, the level of real income being generated will change and equilibrium in the money market would be disturbed. For example, if real aggregate demand increases, real output from the product market will rise and the additional real income will increase demand for real money balances.

If this product market adjustment increases real income to Y₄, the demand for real balances curve will shift to the right to LPy₄ as shown in figure 14.3(a). The increased transaction demand for real money balances will generate an excess demand for real money balances at the old equilibrium rate of r₃. This excess demand for real money balances will induce adjustment in the money market.

Free online money earning sites in bangladesh without investment. Fig. 14. (a) Equilibrium in the money market

Fig. 14.3 (b) Derivation of the LM curve

The market real rate of interest will rise as individuals sell off some of their holdings of bonds and attempt to borrow the additional real money balances desired. The market real rate of interest will rise until the money market reaches the new equilibrium position at the real interest rate r₄. Different equilibrium positions in the money market for various levels of real income are shown in figure 14.3(a)

The relationship between levels of real income and the corresponding equilibrium real interest rates in the money market is called the LM curve. For the real income level Y₃ equilibrium between the demand for real money balances and the quantity of real balances supplied occurs at real interest rate r₃. When real income increases to Y₄ equilibrium in the money market occurs at real interest rate r₄.

The equilibrium positions in the money market for a given supply of real money balances (that is, both a given price level and a given nominal money supply) and a constant anticipated rate of change in prices is shown as the LM curve in figure 14.3(b). The upward sloping nature of the LM curve is the result of the shifts in the demand for real money balance function as the level of real output increases.

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At higher real income levels the demand for real money balances is greater. Thus, reduction of the real rate of interest is necessary to reduce the quantity of real balances demanded for asset purposes so as to bring about equality between supply and demand in the market.

The liquidity trap segment of the liquidity preference curve (demand for real money balances curve) also shows up in the LM curve. If in fact there is a minimum expected level of real interest rates where the asset demand for real money balances is perfectly elastic with respect to the market real rate of interest, the LM curve also would be perfectly elastic in this region. For example, in Figure 14.3 (b) an increase in real income from Y₁ to Y₂ increases the demand for real money balances but this is not sufficient to induce a rise in the market real rate of interest. The same quantity of real balances demanded at the real income level of Y₂ and the real interest rate of r₁ would have been demanded at lower levels of real income.

The Slope and Position of the LM Curve:

The slope of the LM curve depends upon the income elasticity and the interest elasticity of the demand for money. Income-elasticity measures the responsiveness of the demand for money to changes in income while interest elasticity measures the responsiveness of the demand for money to changes in the rate of interest. The larger the income-elasticity, and the lower the interest-elasticity of the demand for money, the steeper the LM curve will be.

What Determines The Demand For Real Money Balances Without

In case the demand for money is relatively insensitive to the interest rate, the LM curve is nearly vertical. If the demand for money is very sensitive to the interest rate, then the LM curve is close to horizontal. In that case, a small change in the interest rate is accompanied by a large change in the level of income to maintain money-market equilibrium.

What Determines The Demand For Real Money Balances Equation

Real visa gift card with money. We know that the real money supply is held constant along the LM curve. It follows that the position of the curve depends upon the amount of real money supply available in the market. A change in the real money supply will shift the LM curve.

Let us consider the effect of an increase in real money supply as a result of which the money supply schedule shifts to the right. At the given level of income and hence with the given demand for real money balances, there is now an excess supply of money. To restore money market equilibrium at the initial level of income, the interest rate has to decline wh