{"id":32058,"date":"2021-09-28T14:26:35","date_gmt":"2021-09-28T14:26:35","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=32058"},"modified":"2026-03-23T08:25:05","modified_gmt":"2026-03-23T08:25:05","slug":"demand-and-supply-of-money-2","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/economics\/demand-and-supply-of-money-2\/","title":{"rendered":"Demand and Supply of Money"},"content":{"rendered":"\n<iframe loading=\"lazy\"\n  width=\"611\"\n  height=\"344\"\n  src=\"https:\/\/www.youtube.com\/embed\/opwhOwJygDA?rel=0&#038;modestbranding=1&#038;playsinline=1&#038;vq=hd1080\"\n  title=\"YouTube video player\"\n  frameborder=\"0\"\n  allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\"\n  allowfullscreen>\n<\/iframe>\n\n\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Monetary and Fiscal Policy (2025 Level I CFA\u00ae Exam \u2013 Economics \u2013 Module 5)\",\n  \"description\": \"For All of the Videos (60 Readings), plus Level I Study Notes, Practice Questions, and Mock Exams: https:\/\/analystprep.com\/shop\/cfa-leve... Topic 2 \u2013 Economics. Module 5 \u2013 Monetary and Fiscal Policy. Timestamps\/LOS: Compare monetary and fiscal policy; functions and definitions of money; money creation process; theories of demand for and supply of money; Fisher effect; roles and objectives of central banks; costs of expected vs unexpected inflation; tools used to implement monetary policy; monetary transmission mechanism; qualities of effective central banks; relationships between monetary policy and economic growth, inflation, interest, and exchange rates; inflation, interest rate, and exchange rate targeting; expansionary vs contractionary monetary policy; limitations of monetary policy; roles and objectives of fiscal policy; tools of fiscal policy and their advantages\/disadvantages; national debt-to-GDP arguments; implementing fiscal policy and difficulties; expansionary vs contractionary fiscal policy; interaction of monetary and fiscal policy.\",\n  \"uploadDate\": \"2022-03-25\",\n  \"thumbnailUrl\": \"https:\/\/img.youtube.com\/vi\/opwhOwJygDA\/hqdefault.jpg\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=opwhOwJygDA\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/opwhOwJygDA\",\n  \"duration\": \"PT31M45S\"\n}\n<\/script>\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"What does the transactions motive for holding money most likely refer to?\",\n    \"text\": \"The transactions motive most likely refers to the desire to hold money for which of the following reasons?\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"To purchase goods and services.\",\n      \"upvoteCount\": 0,\n      \"url\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/economics\/demand-and-supply-of-money-2\/\"\n    },\n    \"suggestedAnswer\": [\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"As a buffer against unseen events.\",\n        \"upvoteCount\": 0\n      },\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"Based on the opportunity or risk available on other financial instruments.\",\n        \"upvoteCount\": 0\n      }\n    ]\n  }\n}\n<\/script>\n\n\n\n<h2><strong>Supply of Money<\/strong><\/h2>\n<p>Like any other market, demand and supply of money will interact to produce an equilibrium price of money.<\/p>\n<p>The graph below shows the supply and demand for money.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter size-full wp-image-18807\" src=\"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2019\/09\/image.png\" alt=\"LM Curve\" width=\"493\" height=\"544\" srcset=\"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2019\/09\/image.png 493w, https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2019\/09\/image-272x300.png 272w, https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2019\/09\/image-400x441.png 400w\" sizes=\"auto, (max-width: 493px) 100vw, 493px\" \/><\/p>\n<p>The money supply (MS &#8211; M\/P) is vertical since it is assumed that there is a constant amount of money at any given time. On the other hand, the money demand (MD &#8211; L(i,Y)) curve is downward sloping since an increase in the interest rate makes the speculative demand for money to fall.<\/p>\n<div style=\"text-align:center; margin: 25px 0;\">\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" style=\"display:inline-flex; align-items:center; justify-content:center; padding:10px 18px; border:2px solid #1a73e8; border-radius:999px; color:#1a73e8; text-decoration:none; font-weight:500; background-color:#f5f9ff; white-space:nowrap;\">\n    Understand money demand, liquidity preference, and interest rate relationships\n  <\/a>\n<\/div>\n<h2><strong>The Demand for Money <\/strong><\/h2>\n<p>The demand for money is the amount of money individuals in an economy wish to hold at a particular time. Bonds, treasury bills, or treasury certificates are not included in the theory of the demand for money. The demand for money is motivated by three main reasons. These reasons are the pillars behind individuals&#8217; desire to hold liquidity (money), and they include:<\/p>\n<ul>\n<li><strong>transaction motive: <\/strong>people hold money because they need it to carry out business and financial transactions;<\/li>\n<\/ul>\n<ul>\n<li><strong>precautionary motive:<\/strong> money is held as a precaution against uncertainty. In other words, people desire to hold money in preparation for any emergency that might occur; and<\/li>\n<\/ul>\n<ul>\n<li><strong>speculation motive:<\/strong> here, money is held in anticipation of a future decline in the prices of assets or goods and services. Holders of money in such an instance aim at benefiting by purchasing assets, goods and services at cheaper prices.<\/li>\n<\/ul>\n<h2><strong>The Quantity Theory of Money<\/strong><\/h2>\n<p>The quantity theory of money is the most discussed theory of money. The theory can be expressed using the equation of exchange:<\/p>\n<p>$$M\\times V = P\\times Y$$<\/p>\n<p>Where:<\/p>\n<p>\\(M\\) is the quantity of money;<\/p>\n<p>\\(V\\) is the velocity of circulation of money in the economy;<\/p>\n<p>\\(P\\) is the price level; and<\/p>\n<p>\\(Y\\) is the real output.<\/p>\n<p>Thus, the amount of money used to purchase goods and services in an economy, M \u00d7 V, is equal to the money value of this output, P \u00d7 Y. However, if the velocity is constant, then the spending, P \u00d7 Y, is relatively proportional to M. The quantity equation can also explain the consequence of money neutrality.<\/p>\n<p>In most cases, if there is money neutrality, then the increase in money supply, M, will not affect the real output, Y, or the velocity of money, V. Since there is no effect of real output, there will be no need to exchange money rapidly. However, it causes the aggregate price to rise.<\/p>\n<p>The quantity theory of money gave birth to the principle that price levels and inflation rates can be controlled by the growth rate of the money supply. As a result, the quantity of money in circulation depends on the level of economic activity.<\/p>\n<blockquote>\n<h3><strong>Question<\/strong><\/h3>\n<p>The transactions motive <em>most likely<\/em> refers to the desire to hold money:<\/p>\n<p>A. as a buffer against unseen events.<\/p>\n<p>B. to purchase goods and services.<\/p>\n<p>C. based on the opportunity or risk available on other financial instruments.<\/p>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>B<\/strong>.<\/p>\n<p>Money held for transactions motive is used to purchase goods and services.<\/p>\n<p><strong>A is incorrect.<\/strong> A buffer against unseen events, is a precautionary motive for holding money.<\/p>\n<p><strong>C is incorrect.<\/strong> The risk available on other financial instruments, refers to the speculative motive.<\/p>\n<\/blockquote>\n<div class=\"notes_inv\"><hr>\n<p><a href=\"https:\/\/analystprep.com\/cfa-level-1-exam\/economics\/learning-sessions-curriculum-economics\/\"><em>Economics &#8211; Learning Sessions<\/em><\/a><\/p>\n<\/div>\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"ImageObject\",\n  \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/images\/demand-and-supply-of-money\",\n  \"contentUrl\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2019\/09\/image.png\",\n  \"url\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2019\/09\/image.png\",\n  \"caption\": \"Demand and Supply of Money\",\n  \"width\": 493,\n  \"height\": 544,\n  \"copyrightNotice\": \"\u00a9 2024 AnalystPrep\",\n  \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\n  \"creditText\": \"AnalystPrep Design Team\",\n  \"creator\": {\n    \"@type\": \"Organization\",\n    \"name\": \"AnalystPrep\"\n  },\n  \"isPartOf\": {\n    \"@type\": \"WebPage\",\n    \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/economics\/demand-and-supply-of-money-2\/\"\n  }\n}\n<\/script>\n<div style=\"text-align:center; margin: 40px 0;\">\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" style=\"display:inline-flex; align-items:center; justify-content:center; padding:12px 20px; border-radius:999px; background-color:#1a73e8; color:#ffffff; text-decoration:none; font-weight:600;\">\n    Start Free Trial \u2192\n  <\/a>\n  <p style=\"font-size:15px; margin-top:12px; color:#555;\">\n    Learn why the demand for money slopes downward with interest rates, how liquidity preference drives this relationship, and how money market equilibrium is tested in CFA Level I economics.\n  <\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>Supply of Money Like any other market, demand and supply of money will interact to produce an equilibrium price of money. The graph below shows the supply and demand for money. The money supply (MS &#8211; M\/P) is vertical since&#8230;<\/p>\n","protected":false},"author":15,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[4],"tags":[],"class_list":["post-32058","post","type-post","status-publish","format-standard","hentry","category-economics","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Demand &amp; Supply of Money | CFA Level 1<\/title>\n<meta name=\"description\" content=\"The supply of money is fixed at a point in time, while demand for money depends on factors like interest rates and economic activity. 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