Understanding Relationships between Money Supply and Liquidity
In a market economy, money is the medium of exchange; producers exchange their goods for money and then exchange that money for other goods. As the production of goods increases, the demand for money expands. Conversely, as economic activity slows down, the demand for money follows suit.
Price changes also affect the demand for money. An increase in the prices of goods and assets increases the demand for money, since people now demand more money to purchase goods that are more expensive. Conversely, a fall in goods prices results in less demand for money.
According to Ludwig von Mises in his book Human Action:
The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of money or a definite weight of money; he wants to keep a cash holding of a definite amount of purchasing power.
Changes in the Supply of Money and L
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