Question

Why is the demand curve for money downward sloping?

Short answer

The demand curve for money is downward sloping because as the interest rate (cost of holding money) increases, the quantity of money demanded decreases. This happens because people prefer to invest or save their money in banks or other financial entities when the interest rate is high, offering more return. And, when the interest rate is low, people hold onto more money, anticipating better investment opportunities.

Step-by-step solution

Understanding Demand for Money

The demand for money is driven by two factors: the need for transactions and the need for precautionary purposes. Money serves as a medium of exchange and a store of value. Therefore, people hold money for daily transactions and as a hedge against future uncertainties.

Interest Rates and Demand for Money

Interest rates play a crucial role in the demand for money. Higher interest rates provide a greater incentive for people to save their money in banks or other financial instruments rather than holding cash. In contrast, when the interest rates are low, people would prefer to hold cash for potential investments because they earn less from saving.

Downward Sloping Demand Curve for Money

The demand curve for money is downward sloping because as the interest rate (cost of holding money) increases, the quantity of money demanded decreases and vice versa. This is because people tend to hold less money and save more in banks or other forms when the interest rate is high for the return it offers. Conversely, if the interest rate is low, people hold more money for possible better investment opportunities.