In economics, what affects our demand for money?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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In order to answer this, we must first understand what the demand for money is.  It is important to realize that this is not a measure of how much money we want to have.  If it were, we would surely have a practically infinite demand for money.  Instead, the term “demand for money” refers to how much of our wealth we want to have in money.  That is, how much of our wealth we want to have in either cash in bank deposits.

There are a number of factors that affect the demand for money.  Let us look at three of the most important.   First, there is the interest rate.  The higher the interest rate the less money people will want to have.  They will, instead, want to invest their money in bonds because that will get them a high return.  Second, there is the amount of income that people have.  As income rises, people will generally want to buy more things.  As they want to buy more things, they need to have more liquid money.  Therefore, higher income leads to a higher demand for money.  Finally, the demand for money is affected by how worried we are about our future.  This is something that economists call the precautionary motive.  If we worry that we will need money to pay for unexpected expenses or because we might lose our job, we are more likely to keep money liquid. 

These are three of the main reasons that the demand for money can vary.