Cambridge International as and a level Economics Ebook

Monetarists: 
economists who argue that control of the 
money supply is essential to avoid inflation.
KEY TERM
The liquidity preference theory
Keynesians argue that the rate of interest is determined 
by the demand for and supply of money. Th
ey assume 
that the supply of money is determined by the monetary 
authorities and is fi xed in the short run. Th
e demand for 
money is explained by 
liquidity preference
. Th
ere are 
three main motives for households and fi rms to hold part 
of their wealth in a money form.
Th
e motive most people will be familiar with is the 
transactions motive
. Th
is is the desire to hold money to 
make everyday purchases and meet everyday payments. 
How much is held by a household or fi rm is infl uenced 
by the income received and the frequency of the income 
payments. Generally, the more income received and the 
more infrequently the payments are received, the higher 
the amount that will be held.
Liquidity preference: 
a Keynesian concept that explains 
why people demand money.
Transactions motive: 
the desire to hold money for the 
day-to-day buying of goods and services.
KEY TERMS
Firms and households usually hold rather more of 
their wealth in money form than they anticipate 
they will spend. Th
is is so that they can meet 
unexpected expenses, and take advantage of unforeseen 
bargains. Th
is is known as the 
precautionary motive
. 
Money resources held for the transactions and 
precautionary motives are sometimes referred to as 
active balances
as they are likely to be spent in the 
near future. Th
ey are relatively interest inelastic so 
that, for example, a rise in the rate of interest will not 
result in households and fi rms signifi cantly cutting 
back on their holdings of money for transactions and 
precautionary reasons.
In contrast, the third motive for holding money 
balances, the