Question

List factors that affect precautionary demand for money.

Answer 1

The precautionary demand is dependent on the size of income, the availability of credit, and the rate of interest. With more income, the precautionary demand will increase because there are more likely to be surprises due to the correspondingly higher expenditures. On the other hand, the more readily available is credit - for e.g., if your credit card limit is very high - the less of a need there is to hold precautionary balances of money. A higher rate of interest represents a higher opportunity cost of holding money for any reason, including the precautionary demand, and so leads to lower precautionary holdings.