Value & Capital, CHAPTER XIX -- THE DEMAND FOR MONEY

In this section, the first one of the chapter, the author, Sir John Hicks, sets up his discussion of what determines an individual's demand for money.

He begins by noting a deficiency in the discussion up to this point of the individual's consumption plan.  This is the simplifying assumption made earlier that any difference between an individual's receipts and expenditures in a time period (e.g. a week) will be made up entirely by an incremental change in his or her holding of securities.  This assumption was made for convenience, but according to Hicks "it would let us down badly in the applications we want to make later on."  And of course it is not truly realistic.

In reality, individuals typically hold some money along with securities and can react to surpluses or deficits by adjusting their holdings of both.  Hicks notes that "It is a matter of considerable importance which form the balancing takes," so he seeks a way of addressing this question within the structure of his theory.  His analysis could easily accommodate money, if money can be treated as though it were some sort of durable consumer good.

It is a condition of equilibrium for the individual that the marginal rate of substitution between acquisitions of any commodities at given dates must equal the ratio of their discounted prices; this rule could be taken as applying to money as well.  The marginal rate of substitution between money now and any other commodity now would equal the current price of that commodity (just the same rule as we found for the standard commodity in statics); the marginal rate of substitution between the acquisition of money now and the acquisition of money at a later date would equal the discount ratio over the period of deferment.  This implies that the interest charge over a period would measure the sacrifice involved in postponing the acquisition of a marginal unit of money to the end of the period .... In other words, the rate of interest would measure the impatience to possess money now instead of money in the future.

The rules for how interest rate changes affect the demand for present commodities would also apply to the demand for money in the present.  Therefore, an interest rate increase "may be expected to diminish the demand for money." Also, a general rise in commodity prices should tend to increase the demand for money.

Hicks concludes the section by stating that these rules for the behavior of money that would apply if it were a durable consumption good are "very reasonable," and that "it would be surprising if more careful attention to the true nature of money were to make it necessary to alter them very considerably."