If the demand for money is the total amount of money that people want, then wouldn’t it just be infinite, considering people want as much money as they can get? I also don’t get why when people’s incomes go up, so does their demand for money. Shouldn’t they be demanding/needing more money when they have less of it?
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3 Answers
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When economists talk about "demand for money", they don't mean, "How much wealth do people want to have?" Because yes, presumably the answer to that would be "infinity", or at least some very big number.
What economists mean is, How much of people's wealth do they want in cash and bank accounts, as opposed to using it to buy things, investing in the stock market, or other things they might do with their money.
You probably own a house, a car, furniture, many other things. Perhaps you own stock or some other investments. Why don't you sell all these things and turn it all into cash? I presume you would say, Because you enjoy having all these things and you don't need the cash. The only reason to have cash is to allow you to buy the things you want.
So that's what economists mean by "demand for money". How much of your wealth do you want in money -- cash and bank accounts. Most of us keep some amount of money on hand to buy things when we want or need them. We may keep some money for emergencies. A few other reasons. But we don't keep all our wealth in cash.
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2$\begingroup$ Don't they often also mean: demand for loans - or money with a price? Demand for anything is infinite, until you factor in the price. Demand for chocolate goes down as price goes up. So does demand for money. $\endgroup$ Commented Nov 22, 2022 at 13:45
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1$\begingroup$ indeed as the other user pointed out demand is always relationship between price and quantity. In case of money the relationship is between interest (price of money) and quantity of money. $\endgroup$– csilviaCommented Nov 22, 2022 at 19:32
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$\begingroup$ @user253751 When economists talk about "demand for money", that's a specific term that is not the same as supply and demand. If we were talking about supply and demand, demand is not a number: it is a line on a graph. That is, it is meaningless to say, "People in place X want to buy 100 loaves of bread per year." You would have to say, "People in place X will buy 100 loaves of bread per year if the price is \$1 per loaf and 70 loaves of bread if the price is \$2 per loaf". Sure, at a price of zero, demand would be, not actually infinite but very large. ... $\endgroup$– JayCommented Nov 23, 2022 at 1:19
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$\begingroup$ ... I say not infinite because even if the store was giving away bread for free, other costs would then become relevant. Like the time it takes to go to the store to pick it up, the need for some place to keep it when I got it home, etc. But that's getting off on a tangent. $\endgroup$– JayCommented Nov 23, 2022 at 1:21
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If we simplify, we can think of people wanting to hold wealth in one of two categories: money or bonds.
You want money when you want to buy things. You can’t buy your lunch with bonds.
On the other hand, bonds accumulate interest. So holding your wealth in bonds is a nice way to accumulate more wealth.
Your demand for money therefore depends on how much you want to buy in the short term and on the interest rate. More transactions means higher money demand. At the same time, a higher interest rate equates to lower money demand as you want to hold more bonds.( In the longer term you can obviously turn your bonds into cash.)
At an aggregate level, the demand for money is the equivalent to the total demand for transactions. The more things that are being bought and sold in the economy, the more money required.
We can formalise this relationship at equilibrium with the equation:
$$\text{M}=\text{€Y}\times \text{L(i)} $$
Where M is money demand, €Y is nominal income, and L(i) is a decreasing function of i, the interest rate.
We can the start to think about how changes in nominal income impact money demand, and indeed how the money supply relates to interest rates.
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Demand exists at a certain price level. For example, the demand for bread is 100 loaves if they cost \$1 and 70 loaves if they cost \$2. If bread is free the demand is presumably as much as people can eat.
When talking about money, the price is the interest rate for loans. The majority of money is created by lending it (and most of the remainder serves as reserves for those loans). For example, the demand may be \$10,000 if the interest rate is 1%, and \$7,000 if the interest rate is 2%. I don't want a million dollars if I have to pay 50% interest rate.
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1$\begingroup$ Hi! Many textbooks and online texts do you use "demand" to mean several things at once, but there are books that very consistently differentiate between quantity demanded (at a price) and demand (function). The precise academic usage of demand covers the function. This is not consistent with the everyday use of the word. $\endgroup$– GiskardCommented Nov 28, 2022 at 17:57