How To Calculate The Demand Real Balance Money Demand Equation
How To Calculate The Demand Real Balance Money Demand Model
How To Calculate The Demand Real Balance Money Demand Graph
How To Calculate The Demand Real Balance Money Demand Curve

Assume That The Demand For Real Money Balance (MXP) Is M/P-0.69 -1001, Where Y Is National Output Andi Is The Nominal Interest Rate. The Real Interest Rate R Is Fixed At 3 Percent By The Investment And Saving Functions. The Expected Inflation Rate Equals The Rate Of Nominal Money Growth. Write Out The Equation That Uses The Growth Rate Of. 2 Reading 13 Demand and Supply Analysis: Introduction INTRODUCTION In a general sense, economics is the study of production, distribution, and con- sumption and can be divided into two broad areas of study: macroeconomics and microeconomics. Macroeconomics deals with aggregate economic quantities, such as national output and national income. Example of the Aggregate Demand Example #1. Suppose during a year, in the country United States, Personal Consumption Expenditures was $ 15 trillion, Private investment and the corporate spending on the non-final capital goods was $4 trillion, Government Consumption Expenditure was $3 trillion, the value of exports was $ 2 trillion and the value of imports was $1 trillion. Money market is in equilibrium at a rate of interest when demand for money is equal to the fixed money supply. Thus money market is in equilibrium when. Money demand (MD) is determined by the level of income and rate of interest. Assuming that money demand is a linear function, we can write it as.

Reading: AB, chapter 7, sections 2 and 3.

The demand for money

Consumption and saving decisions indirectly involve a decision about how much money to hold

Individuals need money for transactions involving consumption goods and services. This is the transactions demand for money.
Given income, what is not consumed is saved. Individuals must then decide how divide their savings into various kinds of assets: cash, savings accounts, government bonds, stocks etc. This is the asset allocation or portfolio problem. Since money pays very little interest (has a low return) the higher the interest rate on non-money assets the higher the opportunity cost of holding money.

Simplifying assumptions

Since the general asset allocation problem involves many different kinds of assets with different risk and return characteristics we simplify this decision by assuming that there are only two kinds of financial assets in the economy.

Money assets - low return, high liquidity and low risk. i_m = nominal interest rate on money assets.
Non-money assets (bonds) - higher return than on money assets and less liquidity. We assume that the risk associated with investing in bonds is not too high (think of government bonds as the generic non-money asset). Let i denote the nominal interest rate on non-money assets. Note that, by assumption, i > i_m. Also, recall that i = r + ^e, where r denotes the real return on non-money assets and ^e denotes expected inflation.

Model for money demand

Our model for the demand for nominal money balances takes the following form:

where

M^d = demand for nominal money balances (demand for M1)

L^d = demand for liquidity function

P = aggregate price level (CPI or GDP deflator)

Y = real income (real GDP)

I = nominal interest rate on non-money assets

r = real interest rate on non-money assets

^e = expected inflation

Remarks

Nominal money demand is proportional to the price level. For example, if prices go up by 10% then individuals need 10% more money for transactions.
As Y increases, desired consumption increases and so individuals need more money for the increased number of desired transactions.
As the nominal interest rate on non-money assets, i, increases the opportunity cost of holding money increases and so the demand for nominal money balances decreases.
Since i = r + ^e, we can decompose the effects on an increase in i into real interest rate increases (holding expected inflation fixed) and expected inflation increases (holding the real interest rate fixed).

The demand for real balances

Since the demand for nominal balances is proportional to the aggregate price level, we can divide both sides of the nominal money demand equation by P. This gives the liquidity demand function or the demand for real balances function:

The left-hand-side of the above equation is the demand for nominal balances divided by the aggregate price level or the demand for real balances (the real purchasing power of money). The right-hand side is the liquidity demand function. The demand for real balances is decomposed into a transactions demand for money (captured by Y) and a portfolio demand for money (captured by i).

The real money demand function is graphed below:

The demand for real balances is graphed as a function of the real interest rate holding income and expected inflation fixed. When the real interest rate is high the opportunity cost of holding money - keeping income and expected inflation fixed - is high so that real money demand is low. Conversely, when the real interest rate is low the opportunity cost of holding money is low so that money demand is high (due to the liquidity convenience of money over bonds). Whenever income or expected inflation change the real money demand curves shifts. For example, if Y increases the real money demand function shifts up and right; if expected inflation increases the real money demand function shifts down and left.

[Next Slide] [Previous Slide] [Contents for Lecture 7] [Slides from Lectures] [301 Homepage]

Last updated on July 15, 1996 by Eric Zivot.

Safety stock is the amount of inventory a business needs to have to achieve a certain level of risk mitigation when it comes to stockouts. There are typically two types of inventory: core and seasonal. Core inventory is inventory that remains in-stock all year round. Seasonal inventory consists of products you bring in for a specific period of time.

Safety stock is also called:

Buffer inventory/stock
Safety stock inventory/stock
Buffer inventory/stock
“Just in case” inventory/stock

The reorder point is calculated using the safety stock metric. It tells a business at what point it is time to place a new order to restock inventory, along with the minimum order and display quantities. This metric accounts for lead time, helping businesses to avoid costly stockouts. We’ll dive into that more later.

The importance of safety stock and reorder point

Stockouts are a costly problem for retail businesses. According to a study conducted by IHL Group, retailers are missing out on $1 trillion in sales every year because of it. Two metrics to consider which help mitigate the risk of stockouts are safety stock and reorder point.

Out-of-stocks happen because of many reasons, including:

Improper, ineffective or inaccurate inventory and operations management practices
Spikes in customer demand
Poor demand forecasting and inventory accounting
Disruptions in production process
Changes in lead time from suppliers

And when stockouts happen, retailers aren’t only missing out on sales. They’re also creating a poor customer experience, and possibly pushing potential lifelong customers to competitors.

Safety stock and reorder point help businesses face these challenges head-on, and maintain a consistent customer experience while also capturing sales — and minimal wasted warehouse space.

Safety stock provides a buffer of inventory for you to dip into when the above circumstances occur, while reorder point provides a buffer of time for you to restock on merchandise. This means fewer rush fees owed to suppliers, less operational chaos, and a more efficient use of warehouse space.

Let’s look at how to calculate these metrics:

How To Calculate The Demand Real Balance Money Demand