Money Supply and Demand Theory Explained

1. THE SUPPLY AND DEMAND THEORY OF MONEY The supply and demand theory of money states that the value of money is determined by the supply of and demand for money. If the supply of money increases, the value of each unit of currency decreases, and if the demand for money increases, the value of each unit of currency increases. The supply of money is controlled by central banks, while the demand for money is determined by factors such as economic growth and interest rates. The market is governed by the law of demand: Demand for commodity implies- the desire to acquire it, (i) willingness to pay for it, (ii) (iii) ability to pay for it. The Law of demand states that: The relationship between Price and quantity demanded is an economic law. The quantity of a good demanded per period relates inversely to its price, other things constant. The law of demand results from (i) Substitution effect, (ii) Income effect. Substitution Effect Substitution Effect : -When the relative price (opportunity cost) of a good or service rises, people seek substitutes for it, so the quantity demanded of the good or service decreases.

2. • Income Effect Income Effect : -When the price of a good or service rises relative to income, people cannot afford all the things they previously bought, so the quantity demanded of the good or service decreases. • Demand Curve and Demand Schedule Demand Curve and Demand Schedule : - • The term demand refers to the entire relationship between the price of the good and quantity demanded of the good. • A demand curve shows the relationship between the quantity demanded of a good and its price when all other influences on consumers’ planned purchases remain the same. • [An exception to Law of Demand: Giffen Goods • A Giffen good is one which people paradoxically consume more of as the price rises, violating the law of demand. For example, during the Irish Potato Famine of the 19th century, potatoes were considered a Giffen good. Potatoes were the largest staple in the Irish diet, so as the price rose it had a large impact on income. • People responded by cutting out on luxury goods such as meat and vegetables, and instead bought more potatoes. Therefore, as the price of potatoes increased, so did the demand.] • Demand Schedule and Demand Curve :- The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. The demand curve is a graph of the relationship between the price of a good and the quantity demanded.

3. Types Of Demand Individual Demand  Market Demand  Autonomous Demand  Durable Demand  Non-Durable Demand  Short-Term and Long-Term Demand  • Factors Influencing Demand Following are the main factors that influence the demand of an object: • Price of good or service (P) • Incomes of consumers (M) • Prices of related goods & services (PR) • Taste patterns of the consumer (T) • Expected future price of the product (Pe) • Number of consumers in a market (N) Market Demand • Market demand is the sum of all individual demands at each possible price. Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

4. Supply • If a firm supplies a good or service, then the firm: 1. Has the resources and the technology to produce it, • 2. Can profit from producing it, and • 3. Has made a definite plan to produce and sell it. • • Resources and technology determine what it is possible to produce. Supply reflects a decision about which technologically feasible items to produce. The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. The Law of Supply • The law of supply states: • The higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied. • The law of supply results from the general tendency for the marginal cost of producing a good or service to increase as the quantity produced increases. Producers are willing to supply a good only if they can at least cover their marginal cost of production. Supply Curve and Supply Schedule • The term supply refers to the entire relationship between the quantity supplied and the price of a good. The supply curve shows the relationship between the quantity supplied of a good and its price

5. when all other influences on producers’ planned sales remain the same. A supply curve is also a minimum-supply-price curve. As the quantity produced increases, marginal cost increases. The lowest price at which someone is willing to sell an additional unit rises. A Change in Supply • The six main factors that change the supply of a good are: • a. The prices of factors of production • b. The prices of related goods produced • c. Expected future prices • d. The number of suppliers • e. Technology • f. State of nature • Market Equilibrium Equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers. The equilibrium price is the price at which the quantity demanded equals the quantity supplied. The equilibrium quantity is the quantity bought and sold at the equilibrium price. The price regulates buying and selling plans. Price adjusts when plans don’t match.