A-LevelEconomicsThe macroeconomy9708/42 · Feb/Mar 2018 · Q525 Marks

Distinguish between the transactions demand for money and the speculative demand for money. Consider which is likely to be more important for a consumer in a modern economy.

(a)Distinguish between the transactions demand for money and the speculative demand for money. Consider which is likely to be more important for a consumer in a modern economy.[12]
(b)Some economists argue that large budget deficits will increase the demand for money while others argue that large budget deficits will decrease the demand for money. Discuss whether it is possible to reconcile these views.[13]

Mark scheme

Marking points from the official mark scheme (Feb/Mar 2018). The mark or mark type is shown in brackets.

Transactions demand is a demand for an active balance. It depends upon the level of income and the frequency of income payments. It is interest inelastic.
Speculative demand for money is determined by expectations of the future rate of interest of long term government securities. These are known as idle balances and closely related to changes in the rate of interest. Importance will vary depending upon the state of economy, the level of income and the rate of interest.
L4 (9-12) for an answer that attempt to discuss the relative importance of each type of demand in an economy. For example, in a recession when incomes are low and interest rates are low, it is likely that the speculative demand for money would be more important than the transactions demand.
Answers should explain the meaning of a budget deficit. The potential effects of large budget deficits on an economy should be identified. A distinction should be made between the short run effects associated with financing a budget deficit and the potential long run effects of deficits on national income. Links should then be established between these effects, ie changes in interest rates and changes in the level of income and how they might affect the demand for money. It is likely that in the short run the speculative demand will fall due to rising interest rates while in the long run transactions demand will rise due to a rise in the level of income.
L4 (9-13) for an answer that focuses upon the difference between the two positions in the statement. Responses will recognise the short run interest rate changes might affect the speculative demand for money but this will depend whether existing interest rates are already high. Also there will be some attempt to evaluate whether the income effect will significantly increase the demand for money. References to the existing state of the economy might be made. A conclusion should be provided which recognises that both claims can be reconciled