In the money demand framework, if the price level increases, holding other factors constant, money demand tends to:

In the money demand framework, if the price level increases, holding other factors constant, money demand tends to:

• A. decrease
• B. remain the same
• C. increase
• D. become more volatile

Answer: (C)

Money demand includes the transaction motive: people hold money to buy goods and services. When the price level rises, the same real amount of purchases costs more in currency. If real activity is held constant, households and firms need more dollars to finance their transactions. So the quantity of money demanded goes up. In other words, higher prices raise the cash balances people want to hold, even with other factors unchanged.

Money demand includes the transaction motive: people hold money to buy goods and services. When the price level rises, the same real amount of purchases costs more in currency. If real activity is held constant, households and firms need more dollars to finance their transactions. So the quantity of money demanded goes up. In other words, higher prices raise the cash balances people want to hold, even with other factors unchanged.