Precautionary demand is the

demand In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given time. The relationship between price and quantity demand is also called the demand curve. Demand for a specific item ...

for highly liquid financial

assets In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value ...

— domestic

money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are as ...

or foreign

currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general def ...

— arising from preparedness for emergency

expenditure An expense is an item requiring an outflow of money, or any form of fortune in general, to another person or group as payment for an item, service, or other category of costs. For a tenant, rent is an expense. For students or parents, tuition is a ...

Overview

economic theory Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...

, specifically

Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output an ...

, precautionary demand is one of the determinants of

demand for money In monetary economics, the demand for money is the desired holding of financial assets in the form of money: that is, cash or bank deposits rather than investments. It can refer to the demand for money narrowly defined as M1 (directly spendable ...

(and credit), the others being

transactions demand Transactions demand, in economic theory, specifically Keynesian economics and monetary economics, is one of the determinants of the demand for money, the others being asset demand and precautionary demand. Overview The transactions demand for mo ...

and

speculative demand The speculative or asset demand for money is the demand for highly liquid financial assets — domestic money or foreign currency — that is not dictated by real transactions such as trade or consumption expenditure. Speculative demand arises fro ...

. The precautionary demand for money is the act of holding

real Real may refer to: Currencies * Brazilian real (R$) * Central American Republic real * Mexican real * Portuguese real * Spanish real * Spanish colonial real Music Albums * ''Real'' (L'Arc-en-Ciel album) (2000) * ''Real'' (Bright album) (2010) ...

balances of money for use in a contingency. As receipts and payments cannot be perfectly foreseen, people hold precautionary balances to minimize the potential loss arising from a contingency. The precautionary demand is dependent on the size of income, the availability of credit, and the

rate of interest In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct ...

. With more income the precautionary demand will increase because there are more likely to be surprises in the timing or size of the correspondingly high expenditures. On the other hand, the more readily available is credit (e.g., the larger is the untapped portion of a credit card's

line of credit A line of credit is a credit facility extended by a bank or other financial institution to a government, business or individual customer that enables the customer to draw on the facility when the customer needs funds. A line of credit takes se ...

), the less of a need there is to hold precautionary balances of money. A higher rate of interest represents a higher

opportunity cost In microeconomic theory, the opportunity cost of a particular activity is the value or benefit given up by engaging in that activity, relative to engaging in an alternative activity. More effective it means if you chose one activity (for example ...

of holding money for any reason, including the precautionary reason, and so leads to lower precautionary holdings. Demand for money Financial markets {{econ-stub