Money Demand, Inflation, and Economic Impacts

Money Demand and Its Determinants

Money demand depends on the price level and the volume of transactions, which is defined as the number of goods and services transacted using money in one year.

Money demand can be represented as: P × T, where T = volume of transactions and P = average price level.

When the money market is in equilibrium, Md = Ms (Money Demand = Money Supply).

Formula: P = (V / T) × M

Assumptions:

1. This theory applies to short-run changes.
2. There is full employment in the economy.
3. The velocity of money and the volume of transactions remain constant.
4. The amount of barter trade remains constant.
5. M, V, and T change independently.

Changes in Velocity of Money (VOM):

• VOM increases: prices decrease = Deflation
• VOM decreases: prices increase = Inflation

Inflation

Inflation: Too much money chasing too few goods - Coulbourn.

Causes of Demand-Pull Inflation (DPI):

1. Increase in the quantity of money
2. Increase in the velocity of money
3. Increase in disposable personal income
4. Effect of expansion of credit

Causes of Cost-Push Inflation:

1. Shortage of factor inputs
2. Industrial disputes
3. Natural calamities
4. Artificial scarcity

Effects of Inflation

Savers:

Savers are adversely affected during inflation. People who save a part of their income in the form of cash or current accounts are losers during inflation.

National Income:

As production is positively affected during inflation, economic activities increase the national income of the country.

Farmers:

Their income increases during inflation as the cost of production was incurred before the rise in price.

Consumers:

They are adversely affected during inflation as their purchasing power decreases, resulting in a fall in consumption.

Production:

It is positive during DPI as the profit margin increases. Production will therefore increase its scale, which will positively impact the economy.