Money Supply Versus Money Demand
According to popular thinking not every increase in the supply of money will have an effect on economic activity. For instance, if an increase in supply is matched by a corresponding increase in the demand for money then there won’t be any effect on the economy. The increase in the supply of money is neutralised so to speak by an increase in the demand for money or the willingness to hold a greater amount of money than before.
What do we mean by demand for money? And how does this demand differ from demand for goods and services?
Now, demand for a good is not a demand for a particular good as such but a demand for the services that the good offers. For instance, individuals’ demand for food is on account of the fact that food provides the necessary elements that sustain an individual’s life and well being. Demand here means that people want to consume the food in order to secure the necessary elements that sustain life and well being.
Also, the demand for money arises on account of the services that money provides. However, instead of consuming money people demand money in order to exchange it for goods and services. With the help of money various goods become more marketable – they can secure more goods than in the barter economy. What enables this is the fact that money is the most marketable commodity.
Demand for money is demand for the medium of exchange
Take for instance a baker, John, who produces ten loaves of bread per day and consumes two loaves. The eight loaves he exchanges for various goods such as fruit and vegetables. Observe that John’s ability to secure fruits and vegetables is on account of the fact that he has produced the means to pay for them, which are eight loaves of bread.
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