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NOTE 11.02. The Money Relation: The Demand for and the Supply of Money

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2. The Money Relation, The Demand For and the Supply of Money

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Money is a commodity that serves as a general medium of exchange. Its exchanges therefore

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permeate the economic system. Like all commodities, it has a market demand and a market supply,

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although its special situation lends it many unique features.

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We saw in Chapter 4 that its price has no unique expression on the market.

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Other commodities are all expressible in terms of units of money, and therefore have uniquely

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identifiable prices.

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The money commodity, however, can be expressed only by an array of all the other commodities,

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that is, all the goods and services that money can buy on the market.

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This array has no uniquely expressible unit, and as we shall see, changes in the array

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cannot be measured.

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Yet the concept of the price or the value of money or the purchasing power of the monetary

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unit is no less real and important for all that.

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It simply must be borne in mind that, as we saw in Chapter 4, there is no single price

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This exchange value of money also takes on peculiar importance because unlike other commodities,

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the prime purpose of the money commodity is to be exchanged, now or in the future, for

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directly consumable or productive commodities.

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The total demand for money on the market consists of two parts, the exchange demand for money

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by sellers of all other goods that wish to purchase money, and the reservation demand

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for money, the demand for money to hold by those who already hold it.

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Because money is a commodity that permeates the market and is continually being supplied

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and Demanded by Everyone, and because the proportion which the existing stock of money bears to

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new production is high, it will be convenient to analyze the supply of and the demand for

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money in terms of the total demand stock analysis set forth in Chapter 2.

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In contrast to other commodities, everyone on the market has both an exchange demand

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and a reservation demand for money.

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The exchange demand is his pre-income demand.

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As a seller of labor, land, capital goods or consumers' goods, he must supply these

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goods and demand money in exchange to obtain a money income.

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Therefore, the exchange demand for money in terms of land, capital goods and consumers'

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will tend to be perfectly inelastic.

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For labor services, the situation is more complicated.

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Labor, as we have seen, does have a reserved use,

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satisfying leisure.

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In determining labor's demand for money, however,

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we can be far more certain.

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To understand why, let us take a hypothetical example.

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At a wage rate of 5 gold grains an hour, 40 hours per week of labor service will be sold.

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Now suppose that the wage rate is raised to 8 gold grains an hour.

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Some people might work a greater number of hours because they have a greater monetary

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inducement to sacrifice leisure for labor.

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They might work 50 hours per week.

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Employers may decide that the increased income permits them to sacrifice some money and take

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some of the increased earnings in greater leisure.

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They might work 30 hours.

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Both would have one thing in common.

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Let us multiply hours by wage rate in each case to arrive at the total money income of

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the laborers in the various situations.

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In the original case, a laborer earned 40 times 5 or 200 gold grains per week.

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The man working 30 hours will earn 30 times 8 or 240 gold grains a week.

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The man working 50 hours will earn 50 times 8 or 400 gold grains per week.

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In both cases, the man earns more money at the higher wage rate.

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This will always be true.

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In the first case it is obvious, for the higher wage rate induces the man to sell more labor.

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But it is true in the latter case as well, for the higher money income permits a man

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to gratify his desires for more leisure as well, precisely because he is getting an increased

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First Money Income Thus a man will always earn more money at

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a higher wage rate, less money at a lower.

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But what is earning money but another name for buying money?

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And that is precisely what is done.

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People buy money by selling goods and services that they possess or can create.

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We are now attempting to arrive at the demand schedule for money in relation to various

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alternative purchasing powers or exchange values of money.

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A lower exchange value of money is equivalent to higher goods prices in terms of money.

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Conversely, a higher exchange value of money is equivalent to lower prices of goods.

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In the labor market, a higher exchange value of money is translated into lower wage rates,

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and a lower exchange value of money into higher wage rates.

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Hence on the labor market, our law may be translated into the following terms.

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The higher the exchange value of money, the lower the quantity of money demanded.

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The lower the exchange value of money, the higher the quantity of money demanded.

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That is, the lower the wage rate, the less money earned.

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The higher the wage rate, the more money earned.

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More important, because more volatile, in the total demand for money on the market is

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the reservation demand to hold money.

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This is everyone's post-income demand.

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After everyone has acquired his income, he must decide, as we have seen, between the

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allocation of his money assets in three directions, consumption spending, investment spending,

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and addition to his cash balance, net hoarding.

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Furthermore, he has the additional choice of subtraction from his cash balance, net

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Dishoarding. How much he decides to retain in his cash balance is uniquely

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determined by the marginal utility of money in his cash balance on his value

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scale. Until now we have discussed at length the sources of the utilities and

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demands for consumers goods and for producers goods. We have now to look at

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The Remaining Good, Money in the Cash Balance, Its Utility and Demand

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Let us suppose that a man's marginal utilities are such that he wishes to have 10 ounces

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of money held in his cash balance over a certain period.

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Suppose now that the exchange value of money, that is, the purchasing power of a monetary

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unit, increases, other things being equal.

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This means that his 10 gold ounces accomplish more work than they did before the change

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in the PPM, purchasing power of the monetary unit.

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As a consequence, he will tend to remove part of the 10 ounces from his cash balance and

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spend it on goods, the prices of which have now fallen.

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Therefore, the higher the PPM, the exchange value of money, the lower the quantity of

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Money Demanded in the Cash Balance. Conversely, a lower PPM will mean that the previous cash balance

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is worth less in real terms than it was before, while the higher prices of goods discourage their

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purchase. As a result, the lower the PPM, the higher the quantity of money demanded in the cash balance.

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There is a third demand for the money commodity that deserves mention.

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This is the demand for non-monetary uses of the monetary metal.

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This will be relatively unimportant in the advanced monetary economy, but it will exist, nevertheless.

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In the case of gold, this will mean either uses in consumption, as for ornaments,

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or productive uses, as for industrial purposes.

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At any rate, this demand also falls as the PPM increases.

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As the price of money, PPM, increases, more goods can be obtained through expenditure of a unit of money.

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As a result, the opportunity cost in using gold for non-monetary purposes increases, and less is demanded for that purpose.

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Conversely, as the PPM falls, there is more incentive to use gold for its direct use.

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From this point on, this non-monetary demand is included for convenience in the total demand

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for money.

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At any one time, there is a given total stock of the money commodity.

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This stock will, at any time, be owned by someone.

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It is therefore dangerously misleading to adopt the custom of American economists since

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Irving Fisher's day of treating money as somehow circulating, or worse still, as divided

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into circulating money and idle money.

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This concept conjures up the image of the former as moving somewhere at all times, while

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the latter sits idly in hordes.

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This is a grave error.

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There is actually no such thing as circulation, and there is no mysterious arena where money

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moves.

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At any one time, all the money is owned by someone, that is, rests in someone's cash

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balance.

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Whatever the stock of money, therefore, people's actions must bring it into accord with the

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The Total Demand for Money to Hold, that is, the total demand for money that we have just

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discussed.

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For even pre-income money acquired in exchange must be held at least momentarily in one's

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cash balance before being transferred to someone else's balance.

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All total demand is therefore to hold, and this is in accord with our analysis of total

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Total Demand in Chapter 2.

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Total stock must therefore be brought into agreement on the market with the total quantity

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of money demanded.