This is the total stock of money or money supply which is made up of coins, currency notes, bank notes, (and gold and silver in some countries) that exists in circulation within the economy at a particular period of time. In Nigeria, money held on demand or demand deposits in banks are as well classified along with the stock of money in circulation. The supply of money in the economy is left to the Central Bank, the apex financial institution, to determine and regulate.
However, during inflationary periods, supply of money often increases, due to increasing demand for money.
Demand for Money
Money is a perfectly liquid asset since it can be exchanged for any other goods or services. Money is held in cash as opposed to investing it in bonds, shares, and stocks because of some basic ulterior motives identified by Lord Gerald Manley Keynes:
(i) Transactionary Motive
Individuals and corporate bodies in an economy prefer to hold certain amount of money in cash so as to meet their day-to-day pressing needs.
Individuals on a daily basis will hold cash for the purpose of feeding themselves, transporting themselves, and making payment for other basic transactions on a day-to-day basis. The amount of cash or money a man holds will depend on the interval he receives his income and the income itself.
Corporate bodies too hold money to offset daily payment for goods and services and the amount of cash or money a firm keeps in its cash box depends on the type of business it engages in and the frequency with which it makes payment for services. This transaction motive implies that payments arid receipts are not perfectly synchronized.
(ii) Precautionary Motive
Lord Keynes says this motive induces individuals and firms within the economy to hold money in cash purposely to offset any unexpected emergencies or contingencies.
In the case of an individual, he holds money so as to offset unexpected medical expenses, for him self or family members, car repairs and other sudden emergencies.
Firms hold money to offset contingencies emanating from various departments in form of repair of vehicles, maintenance of machinery and transport of staff and so on.
(iii) Speculative Motive (Asset Motive)
The amount of money held for speculative motive is a function of the expected trends in the rate of interest. If the expected rate of interest increases, individuals and firms will hold
money now and invest later, but if the rate of interest is expected to fall then, they will rather
invest now. Consequently, they will bold less money in form of cash.
Speculative/asset demand for money varies inversely with the rate of interest.
Value of Money and the Price Level
Since the demand for money is derived demand (people demand money for the sake of what
it can buy). The amount of money demanded is dependent on the real value of money. The
real value of money is the quantity of goods and services that money can buy; it is as well
called Purchasing Power of money.
The purchasing power of money is inversely related to the price level. The higher the
price level, the smaller the quantity of goods and services that a given amount of money can
buy. Consequently, the lower the value of money.
On the other hand, the lower the general price level, the greater the quantity of goods and
services that money can buy and the higher the value of money or purchasing power. This
can be illustrated with this example. In 1984, a higher education notebook cost N4.OO but
now it costs 48.OO. This shows that the price level has increased thereby reducing the
purchasing power of money from two notebooks for 8 in 1984 to one now.
Price level is determined with the use of price index. A price index is a method of
compiling average price changes far a group of goods and services. The price changes will
enable us to determine the changes in the purchasing power of money. Price index is computed for a variety of purposes. Therefore, there exist different types of price index:
(i) Wage index;
(ii) Import prices index;
(iii) Cost of living index;
(iv) Index of share prices;
(v) Index of wholesale prices.
computation of a Price index
When computing any of the aforementioned types of price index, the following guidelines must be followed:
(I) The first step is to select a group of commodities that best fits the type of price index you plan to compute. For instance, if you want to compute an import-price index; then you select specific number of import commodities. This is as well referred to as basket of commodities.
(ii) The second step is to select the base year. The base year is the year that will form the basis of comparison; a year that has more stable, normal prices is preferably chosen so as not to distort the result of the price index.
(iii) Third step is the selection of an income group. It is necessary that the group should be a good sample of the total population for which the index is being compiled.
(iv) The fourth step is assignment of appropriate weight to each of the sample commodity selected. This should reflect the relative importance of each commodity to other commodities in the basket of commodity.With the above techniques and computation steps taken, we will have a result of an index number, which will show us whether price level has increased or decreased relative to the
base year price level. For instance, if we have these price index numbers (1985 base year)
100%, 1990 = 150%. This means that the basket of commodities which normally cost N 100
in 1985; costs 150 in 1990. It implies that the price level has risen by 50% over the period
1985-1990. Thus, the value of money has fallen by 50%.
Problems of Price indices
(I) The choice of a base year is often the major problem in computing price indices simply because it is difficult to find a year with reasonable stable prices. Consequently the base year selected is often based on subjective considerations.
(ii) Determination of appropriate weight to commodities is another major problem. different weights, such weights will Consequently, such price index can not results.
fix to each commodity in the basket of Since different individuals will fix for yield different price index numbers, result ha objective results but subject
(iii) Price indices are not useful for long-term comparisons since prices are not static and likewise the basket of commodities consumed changes over time because of changes in income and taste and fashion.
(iv) It is often difficult to determine or select a specific group for the computation.of indexation; since most of the people in the same income group do not distribute their expenditure on the same commodities.
Based on the above-mentioned problems of computing price indices; we can realise that price index does not provide a satisfactory measure of the value of money; rather it can be called an average measure of changes in the value ofmoney or purchasing power of money
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