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Macroeconomics

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Moderate

Liquidity Preference Model with Numbers

MACRO-XJRZC7

In the liquidity preference framework, agents in the economy (i.e. firms, households, governments, etc.) desire to hold money for the purpose of having ready cash on hand in order to purchase goods and services easily.

Suppose this function can be written as $\frac{M}{P} = \sqrt{\frac{cY}{2i}}$, where $M$ is nominal money holdings by an agent, $P$ is the price of a basket of goods or the general level of prices, $i$ is the nominal interest rate, $Y$ is GDP, and $c$ is a constant. This is the form the real money demand function takes in the Baumol-Tobin model of money demand.