Question

According to the portfolio theories of money demand, what are the four factors that determine money demand? What changes in these factors can increase the demand for money?

Short answer

Four factors are interest rates, wealth, risk of alternative assets, liquidity of other assets.

Decrease in interest rates and liquidity of alternative assets increases the demand for money

Higher wealth and a higher risk of alternative assets increases money demand.

Step-by-step solution

Step 1. Define demand.

Demand is the amount of a good that buyers are willing and able to buy at various prices over a certain time period.

Step 2. Explanation

According to portfolio theory, the four factors determining money demand are: interest rates (lower interest rates increase money demand); wealth (higher wealth leads to higher money demand); risk of alternative assets (a greater risk of alternative assets tends to increase money demand); and liquidity of those other assets (a decrease in liquidity of other assets increases the demand for money).