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This analysis however breaks down if the demand for money is not stable – for example, if velocity in the above equation is not constant. In that case, shocks to money demand under money supply targeting will translate into changes in real and nominal interest rates and result in economic fluctuations.
The liquidity-preference relation can be represented graphically as a schedule of the money demanded at each different interest rate. The supply of money together with the liquidity-preference curve in theory interact to determine the interest rate at which the quantity of money demanded equals the quantity of money supplied (see IS/LM model).
To compute the inverse demand equation, simply solve for P from the demand equation. [12] For example, if the demand equation is Q = 240 - 2P then the inverse demand equation would be P = 120 - .5Q, the right side of which is the inverse demand function. [13] The inverse demand function is useful in deriving the total and marginal revenue ...
The Baumol–Tobin model is an economic model of the transactions demand for money as developed independently by William Baumol (1952) and James Tobin (1956). The theory relies on the tradeoff between the liquidity provided by holding money (the ability to carry out transactions) and the interest forgone by holding one’s assets in the form of non-interest bearing money.
The Cambridge equation focuses on money demand instead of money supply. The theories also differ in explaining the movement of money: In the classical version, associated with Irving Fisher , money moves at a fixed rate and serves only as a medium of exchange while in the Cambridge approach money acts as a store of value and its movement ...
Mathematically, the LM curve is defined by the equation / = (,), where the supply of money is represented as the real amount M/P (as opposed to the nominal amount M), with P representing the price level, and L being the real demand for money, which is some function of the interest rate and the level of real income.
[20] [36] Secondly, there is general agreement that velocity does change over time, [36] and sometimes in unpredictable ways, because of changes in the money demand function; this may e.g. be the consequence of changes in the infrastructure of payment systems. This was considered a major problem during the 1970s and 1980s when several major ...
The money demand function is often conceptualized in terms of a liquidity function, (,), = (,) where is real income and is the real rate of interest. If is taken to be a function of , then in equilibrium