Value of money is directly affected by demand and supply of money.
Supply of Money Definition:
By the term supply of money we mean “The amount of money which people have with them” OR “The amount of money which people spends to meet their needs”.
Usually money circulates in the form of coins and currency notes but also in the form of credit money. The more money a country possess the more supply of money it has. There is a difference in supply of money and supply of other goods, as other goods comes to an end (consumed) after using them, whereas in the case of money the more it circulates the more its supply rises.
Sources of Money Supply:
Following are the sources of Money Supply:
One source of supply of money is the individuals’ savings. By individual savings we mean the money saved by the individuals from their income in specific time period. People usually save their money in banks, which circulates this money forward in the form of loans. Different people have different reasons to save money. Some people need it for future investments; others need it to meet some unexpected requirements etc. Savings of an individual depends on two factors:
- Will to Save (It means that the determination of an individual to save some amount of money from their income)
- Power to Save (It means that how much income an individual have from which he/she can save some money)
By the term corporate savings we mean the amount of money which is not distributed among the shareholders by the corporate bodies (such as companies). The purpose of non-distribution by such corporate bodies could be planning for future investment or to meet unexpected future emergencies.
For example: If a corporate investment company earns 10 million dollars, ideally, the company should distribute this whole amount of 10 million dollars to its shareholders (after all this is their money). But companies normally do not do such thing. They hold a specific amount e.g. 4 million dollar in our example to be used in future emergency requirements. This specific amount of withheld money is known as corporate savings.
Governments manages their budget per annum, they estimates the total income earned from different sectors and also measures the expenditures spent on these sectors, if the income is more than expenditures than it will be called as surplus budget. This surplus is known as public savings. Following three are the most crucial sources of government earnings:
- Governments get money from different taxes imposed on public
- Governments can increase their income from the foreign loans
- Governments also have the ability of deficit financing to increase their income
A market where shares are brought to buy and to sell is called stock market. Stock market also increases the supply of money. People who need money bring their shares and sell in the market. Through stock exchange people invest their savings, which cause the supply of money to increase. In stock market following items are transected:
- Bonds and Savings Certificates
- Government securities
People usually save their money in banks. The banks keep some amount from this money according to specific proportion and give the remaining money as loan. The same loan is again deposits in bank and bank again grants this money as loan after keeping some amount as reserve. This is how bank creates credit. Advancing loans increase the supply of money.
Insurance companies are also able to increase the supply of money. People deposits their money for some fixed time as an insurance, so that they can take this money back with interest. After getting the insurance policy people deposits fixed premium for a fixed time, this premium is returned by the company after the specific time period with interest.
Demand of Money:
Demand of money means “The amount of money which people want as cash with them”.The desire to keep more money as cash the more the demand of money will increase.
Following are the factors on which demand of money depends:
Everyone has to keep some cash to meet their day to day expenses such as food, clothing, household things etc. It is a fact that the more a person has money the more he/she desire consumption. To meet more expensive and luxuries, people need more money thus demand of money increases.
Some people want to keep some cash with them to get rid of natural calamities such as sickness, earthquake and heavy rains etc. People also keep cash for emergency expenditures. A person is to be called rational if he/she keeps some money for bad time.
Businessmen sell and buy their commodities on daily basis, to serve such purpose they have to keep some money as cash with them. There is greater demand of cash for greater business. Three motives explained above are known as Transactionary Demand for Money. Demand of money is function of income and it is an increasing function that is as the income increase the demand for money increases and vice versa. This relationship is shown in the diagram:
In speculation, people earn money through the fluctuation in prices of goods and services. A speculator keeps the prices in his/her mind. When prices fall, he/she buy the goods or services at low rates and then sell them when the prices are high. In such way a speculator earns money. People therefore need cash with them for speculation.