Wealth Effect on the Demand for Money

Abstract

The wealth effect on the individual's money demand is examined within the inventory theoretical framework involving stochastic cash needs. A positive wealth effect arises if an increase in wealth increases the individual's planned expenditure beyond his expected receipts, or if the marginal yield on earning assets is diminishing or marginal penalty cost is increasing. The direct wealth effect due to decreasing absolute risk aversion is negative rather than ambiguous as obtained by Arrow (1971). Finally, interpreting penalty cost as the utility lost due to inadequate money holding could give rise to a positive wealth effect, but the presence of near-money assets makes it negative.