Question

The three basic reasons for holding money are for a) transactions purposes, b) precautionary purposes and c) possible profit or speculation purposes. Given these three motives, indicate which might be most important for the following people; i) a student on a small allowance from his parents ii) a financially conservative professor with young children to support iii) a "wheeler-dealer"

Short answer

i) For a student on a small allowance from his parents, the most important reason for holding money would be for transactions purposes, to manage daily expenses. ii) For a financially conservative professor with young children to support, the most important reason for holding money would be for precautionary purposes, to ensure a secure future for their family. iii) For a "wheeler-dealer," the most important reason for holding money would be for possible profit or speculation purposes, to capitalize on risky investment opportunities.

Step-by-step solution

i) Student on a small allowance from his parents

For a student on a small allowance from his parents, transactions purposes would most likely be the most important reason for holding money. The student's primary focus would be on managing money and payments for everyday expenses such as food, transportation, and study materials. Thus, having money for transactions on everyday necessities and expenses takes priority.

ii) Financially conservative professor with young children to support

For a financially conservative professor with young children to support, the most important reason for holding money would be precautionary purposes. As a responsible and conservative parent, the professor would be more concerned about ensuring they have enough money saved for emergencies or unexpected expenses related to their children's needs, health, or education. This will enable them to provide a secure future for their family.

iii) A "wheeler-dealer"

For a "wheeler-dealer," the most important reason for holding money would be for possible profit or speculation purposes. A "wheeler-dealer" is usually someone involved in making risky investments or transactions with the intent to make a significant profit. They would prioritize holding money to capitalize on investment opportunities that may arise or to speculate in markets where they believe they can make substantial gains.

Key concepts

Transactional Money Demand

The concept of transactional money demand refers to the need to hold cash for everyday transactions. Imagine you're a student living on a modest allowance. Every dollar counts, and your financial focus is centered on covering your daily costs, like affordable meals, transport to classes, and perhaps the occasional coffee with friends. The money you hold serves a simple purpose: to facilitate these regular purchases. In economics, this is what we call transactional demand for money; it's the cash you need on hand to make sure you can complete day-to-day transactions without a hitch.

In practice, the transactional demand for money can be influenced by several factors, such as the frequency of your paychecks or the steadiness of your expenses. For individuals with very predictable financial lives, managing this aspect of money holding is often straightforward. However, when income is irregular or expenses are unpredictable, the importance of holding enough money for transactional purposes becomes paramount to avoid running out of cash at critical moments.

Precautionary Money Demand

Now, envision yourself not as a student, but as a financially conservative professor with a young family. Your priority shifts; it's no longer just about making ends meet day-to-day. Instead, you're now looking at the precautionary money demand. This is the money you reserve 'just in case' - for unexpected medical bills, sudden home repairs, or even last-minute school expenses for your kids.

The core idea here is to have a financial cushion, a security blanket that offers peace of mind. The size of this cushion can vary depending on personal risk tolerance and lifestyle. For financially conservative individuals, a larger reserve might be preferred to cover potential emergencies or unplanned outlays, ensuring that life's surprises don't turn into financial crises. This is a form of self-insurance, a hedge against the unpredictable twists and turns of life.

Speculative Money Demand

Moving on from the professor to a more adventurous character, the speculative money demand comes into play when you step into the shoes of a 'wheeler-dealer'. Imagine being constantly on the lookout for opportunities to invest, to take measured risks that could potentially yield high returns. Here, you're not saving money for a rainy day or using it solely for everyday transactions; you're holding funds to swiftly exploit investment opportunities that could come your way.

Whether it's stocks, bonds, real estate, or other assets, the speculative demand for money is all about timing and market predictions. If you believe that the market will move in a certain direction, you might want to hold liquidity to purchase assets when they are undervalued and sell them when the price is right. It's a delicate balance of holding enough money to seize these opportunities without missing out on other potential investments because your funds are tied up in less liquid forms.