I am currently looking through Mankiw "Economics" (5th edtion).

I have come across this statement on page 664. When talking about lowering taxes to stimulate the economy

[lowering taxes, increases disposable income and...] "Increased incomes lead to higher money demand". [which tends to lead to higher interest rates and thus crowding out investment and offsetting the effects of lower taxes]

I am not sure of the logic behind this statement.
It feels like saying "If I give someone more apples, they will demand more apples". OK I can see the argument that the more we have the more we desire. But I have a feeling that that's not the line of argument here - not very "Mankiwian".

Can anyone explain why having more "money in your pocket" increases demand for money?


1 Answer 1


Higher income is not the same as having more money in your pocket since the income is a real income which can increase even with amount of money in your pocket being exactly the same as before.

Next money demand increases because, at the higher level of income, people will want to spend more since consumption is increasing function of income and thus people will want to hold more money to support this consumption at any interest rate.

You can see this visualized at a graph below that I took from Melvin & Norrbin 2017. Note even when money demand increases because of increase in real income $Y$ (i.e. $M^d$ shifts to $M^{d'}$) the total amount of money does not have to change like in the picture below, but it could if $M^S$ would be less than perfectly inelastic.

enter image description here

  • $\begingroup$ I find this conceptually so confusing. Income increases in real terms (e.g. due to deflation or an inflation beating payrise). But I have what I have in my bank account and maybe now I'm wealthier I'm going to spend more of that money (MPC rises with income). But still that money is in my bank account (electronically). The bank has my income as a liability on its balance sheet. I can spend that money I haven't demanded a higher quantity of money, What am I doing wrong here? $\endgroup$
    – Studi
    Dec 15, 2022 at 10:04
  • $\begingroup$ @Studi 1. higher income does not mean you have more money on your bank account. Again we are talking about real income. 2. MPC declines with income. Rich people have lower MPC than poor people. Consumption does increase with income but not MPC. 3. A person individual money demand is the amount of money they want to hold at some period of time at a particular interest rate $\endgroup$
    – 1muflon1
    Dec 15, 2022 at 11:28
  • $\begingroup$ With regard to MPC. I've managed to write completely the opposite of what I want to say. My apologies. $\endgroup$
    – Studi
    Dec 16, 2022 at 11:09
  • $\begingroup$ Back to the "demand for money". In my first comment I was trying to address an increased real income (i.e. through deflation or an inflation beating payrise). Either people get paid more or prices fall to make real income higher They have a balance in their bank following this. If that money shifts between their bank account and the shop where they bought something there hasn't been any money "demanded". $\endgroup$
    – Studi
    Dec 16, 2022 at 11:29
  • 1
    $\begingroup$ @Studi no income is not person's money supply, those are two different variables if we talk about real income as defined in economics (and which is what Mankiw talks about). Even if we talk about nominal income, its not money supply because supply has to be on some market, when you get something from someone thats not your supply of thing as understood in economics (you seem to mix the economic definition of supply with common english usage of the word) $\endgroup$
    – 1muflon1
    Jan 17, 2023 at 17:47

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.