Which of the following factors would increase the transactions demand for money?

Question

Which of the following factors would increase the transactions demand for money?

Option a: Rumors that a computer virus had invaded the ATM network

Option b: A fall in nominal income

Option c: Lower nominal interest rates
revised jrl 07-26-2011

A. Only option b would increase the transactions demand for money as people would be spending more on goods and services in the face of a fall in nominal income.

B. Both options a and c would increase the transactions demand for money. Lower nominal interest rates would reduce the opportunity cost of holding money, while a computer virus in the ATM network would lead to worries about the system closing down. Both of these factors will increase the transactions demand for money.

C. Only option a would increase the transactions demand for money as a computer virus in the ATM network would lead to worries that the system would shut down. Lower nominal interest rates and a fall in nominal income would both lead to a fall in the transactions demand for money.

D. Only option c would increase the transactions demand for money due to the lower opportunity cost of holding money. Options b and a would both lead to a fall in the transactions demand for money.

Explanation / Answer

Transaction demand of money is the one that arises due to non synchronous payments and receipts sequences. It is used to bridge the gap between non concurrent payment requirements and receipts. It is usually money in its most liquid form i.e cash and/or checking account balances and is something that is held by corporates, consumers and the government to satisfy their most immediate monetary needs and facilitate daily transactions.

Option B is the correct answer as any expected threat to proper functioning of ATMs ( such as one created by a virus in the ATM network) which might result in widespread shortage of liquid money ( cash ), will spur people to hold more liquid money to meet their daily transactional needs thereby increasing transaction money demand. A lower nominal interest rate would also increase transaction demand of money as people would want to divest low nominal interest paying investments and hold the divestment proceeds as cash so as to meet their daily transactional requirements. Cash would be preferable to low interest paying investments as regular withdrawal of cash involves transaction costs which might not be covered by returns from investments owing to low nominal interest rates.

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