In many countries, people hold money as a cushion against unexpected needs arising from a variety of potential scenarios (e. g., banking crises, natural disasters, health problems, unemployment, etc.) that are not usually covered by insurance markets. Explain the effect of such a behavior on the precautionary component of the demand for money.

precautionary demand for money is classified as money that are held to cover for unforeseen occurrence e. g, an accident or illness.

It should also be noted that: The amount of money held for such purposes is broadly dependent on the level of income and expenditure.

With more income the precautionary demand will increase because there are more likely to be surprises in the timing or magnitude of the correspondingly high expenditures

A higher rate of interest represents a higher opportunity cost of holding money for any reason, including the precautionary reason, and so leads to lower precautionary holdings.