Economics of Money, Banking and Financial Markets, The, Business School Edition (5th Edition) (What's New in Economics)
Question
Book Icon
Chapter 22, Problem 14Q
To determine

In case the question requires us to explain the four factors that determine the demand for money according to the portfolio theory.

Concept Introduction:

Portfolio theory: American economist James Tobin justified that rational individuals will keep portfolio of consisting of money (cash) and bond rather than keeping wealth either in money (cash) or bond. According to Tobin, people are in general risk averse. Human behaviour demonstrates risk aversion. This implies that, they have a preference towards lesser risk at a given rate of return. In the Keynesian analysis, the wealth of a person is either in the form of all money or all bonds depending on his expectation of the future rate of interest. According to Tobin, faced with various safe and risky assets, individuals prefer to diversify their portfolio by sharing their wealth in a balanced combination of safe and risky assets. According to him, an investor is confronted with a dilemma of what quantity of his portfolio of assets should be in the form of money (without any interest) and interest-earning bonds. Portfolio theory highlights the function of money as a store of value. Money presents a blend of risk and return as compared other assets which are less liquid than money — such as bonds.

According the money portfolio theory, demand function of money is expressed as:

(M/P)d = f(rs, rb, pe, W)

Where rs = the expected real return on stock, rb = the expected real return on bonds, pe = the expected inflation rate and W= real wealth.

The four factors that determine the demand for money are:

  1. Expected real return on stocks (rs)
  2. Expected real return on bonds (rb)
  3. Expected inflation rate (pe)
  4. Real wealth (W)

Blurred answer
Knowledge Booster
Background pattern image
Recommended textbooks for you
Text book image
ENGR.ECONOMIC ANALYSIS
Economics
ISBN:9780190931919
Author:NEWNAN
Publisher:Oxford University Press
Text book image
Principles of Economics (12th Edition)
Economics
ISBN:9780134078779
Author:Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:PEARSON
Text book image
Engineering Economy (17th Edition)
Economics
ISBN:9780134870069
Author:William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:PEARSON
Text book image
Principles of Economics (MindTap Course List)
Economics
ISBN:9781305585126
Author:N. Gregory Mankiw
Publisher:Cengage Learning
Text book image
Managerial Economics: A Problem Solving Approach
Economics
ISBN:9781337106665
Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:Cengage Learning
Text book image
Managerial Economics & Business Strategy (Mcgraw-...
Economics
ISBN:9781259290619
Author:Michael Baye, Jeff Prince
Publisher:McGraw-Hill Education