Transaction Demand for Money and its Relation with Value of Transaction – Explained

Read this article to learn about the transaction demand for money and its relation with value of transaction:

(a) Transaction demand for Money (M_T^d):

Transaction demand for money is the amount of money required for current transactions of individuals and firms.

It is the quantity of money that all the Individuals and firms desire to keep on hand for the purpose of financing their forthcoming expenditure.

The main reason to hold money in cash for meeting day-to-day transactions is to bridge the interval between receipt of income and expenditure. For instance, a worker who gets his wages on the first day of the month has to spend it continuously throughout the month on purchase of goods and services.

The same consideration applies to businessmen. In short, the principal motive for holding cash is to carry out transactions. For simplifying the discussion, we aggregate precautionary demand for money (to provide for emergencies like sickness or accident) with transaction demand.

According to Keynes, transaction demand for money is mainly determined by the level of income. It is positively associated with the level of Income. Higher the level of income, the larger would be the size of money-holdings for transactions.

For example, the size of transaction demand for money at income level of Rs 1,000 crore will be larger than that at the income level of 700 crore. Mind, it is not the size of national income but proportion of it which people hold as cash balance that determines the transaction demand for money it is perfectly interest inelastic.

(b) Relationship between transaction demand for money and value of transactions:

The transaction demand for money of the economy is fraction of total value (volume) of transactions over a unit period of time.

Symbolically:

M_T^d = K.T

It shows that transaction demand for money M_T^d is a positive fraction (K) of total value of transactions (T). This can be clarified with a simple example of two-person economy consisting of one person’s firm and the other person a worker. Suppose, the worker gets a salary of Rs 1,000 on the first day of every month and spends over the month his entire income on goods and services produced by the firm.

His monthly cash balance at the beginning of the month is Rs 1,000 and at the end of the month is Rs 0. As against it, the firm has Rs 0 balance at the beginning of the month and Rs 1,000 at the end of the month through its sales to the worker. Average money holding of worker is Rs 500 (= 1’000 + 0/2) and of the firm is also Rs 500 (= 0+1.000/22).

Clearly whereas transaction demand for money is Rs 1,000 (= 500 by the worker + 500 by the firm), the total volume of monthly transactions in the economy is Rs 2,000 as the firm has sold its goods and services worth Rs 1,000 to the worker and the worker has sold his services worth Rs 1,000 to the firm. Hence, the transaction demand for money is a fraction (here 50%) of total volume of transactions over a unit period of time.