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State and explain Keynes’s THREE motives for holding money - Leaving Cert Economics - Question c - 2006
Question c
State and explain Keynes’s THREE motives for holding money. Explain, with the aid of a diagram(s), Keynes’s theory on the relationship between the holding of money ... show full transcript
Worked Solution & Example Answer:State and explain Keynes’s THREE motives for holding money - Leaving Cert Economics - Question c - 2006
Step 1
State and explain Keynes’s THREE motives for holding money.
Answer
Keynes identified three primary motives for holding money:
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Transactions Motive: People hold money to facilitate everyday transactions for goods and services. This allows for immediate exchange without the need to convert assets into cash, providing liquidity.
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Precautionary Motive: Individuals hold money as a safeguard against unexpected expenses or emergencies. This motive ensures that they have liquid assets available when unforeseen circumstances arise.
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Speculative Motive: This motive arises from the desire to hold cash to take advantage of potential investment opportunities. Individuals may choose to hold money to avoid missing out on favorable conditions in the financial markets.
Step 2
Explain, with the aid of a diagram(s), Keynes’s theory on the relationship between the holding of money and the rate of interest.
Answer
Keynes theorized that the demand for money is inversely related to the rate of interest. As the interest rate decreases, the opportunity cost of holding money decreases, leading to an increase in the quantity of money held. Conversely, as the interest rate rises, individuals prefer to invest their money to earn interest rather than hold it in liquid form.
To illustrate this, consider the following diagram:
Money Demand
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Interest Rate __|_____
In the diagram, the downward sloping curve indicates that as the interest rate falls, the demand for money rises. This relationship underscores the importance of interest rates in monetary economics and fiscal policy.