Explain the economic reasons for holding cash.

The economic reasons for holding cash are transactions demand, precautionary demand, and speculative demand. Transactions Demand: Firms need money in the bank to pay bills for the goods and services they use. Payments are made to employees, vendors, utility companies, and taxing authorities, to name just a few. At the same time, most receipts come in the form of checks that are deposited in the bank. The constant flow of money in and out of the bank gives rise to an average account balance that we associate with transactions. Precautionary Demand: It refers to firms keeping cash on hand to pay for emergency needs. For example, suppose a shipment intended for a demanding customer is accidentally damaged on the loading dock, and a new shipment has to be produced immediately. That could require extra labor at overtime rates and the quick acquisition of new raw materials. Speculative Demand: Firms keep cash available to take advantage of unexpected opportunities. For example, suppose the price of a particular input drops suddenly, but is expected to go up again quickly. If cash is available, a bargain can be had; if not, it has to be passed up. Firms keep money on hand to take advantage of such opportunities.