Money demand & supply

Everything You Need in One Place

Homework problems? Exam preparation? Trying to grasp a concept or just brushing up the basics? Our extensive help & practice library have got you covered.

Learn and Practice With Ease

Our proven video lessons ease you through problems quickly, and you get tonnes of friendly practice on questions that trip students up on tests and finals.

Instant and Unlimited Help

Our personalized learning platform enables you to instantly find the exact walkthrough to your specific type of question. Activate unlimited help now!

0/4
?
Intros
Lessons
  1. 4 Factors for the Quantity of Money
    • Price Level
    • Real GDP
    • Nominal Interest Rate
    • Financial Innovation
  2. Money Demand Curve
    • Demand for quantity of real money
    • Real GDP \, \uparrow \, \, Money Demand \, \uparrow \,
    • Real GDP \, \downarrow \, or Financial Innovation \, \, Money Demand \, \downarrow \,
  3. Money Supply Curve
    • Supply for quantity of real money
    • Banks & Fed control supply
    • Money Supply \, \uparrow \, \, Shift right
    • Money Supply \, \downarrow \, \, Shift left
    • Given Time period
  4. Short-Run & Long-Run Equilibrium
    • Intersection of demand and supply
    • Supply Curve Shifts right \, \, decrease interest rate
    • Supply Curve shift left \, \, increase interest rate
    • Demand curve shift right \, \, increase interest rate
    • Demand curve shift left \, \, decrease interest rate
    • Long-Run \, \, no changes, only price level
0/0
?
Examples
Topic Notes
?

4 Factors of Money Holding

The quantity of money demanded is the amount of money people plan to hold on any given day. The amount of money that people plan to hold is based on the following 4 factors:

  1. The Price Level: The changes in price level causes someone to hold more or hold less nominal money (the quantity of money measured in dollars).

    Nominal money is proportional to the price level. Others remaining the same, if the price level
    1. Increases by xx %, then people hold xx %, more nominal money.
    2. Decreases by xx %,, then people hold xx %, less nominal money.

    Real money is the quantity of money measured in constant dollars (2005 dollars), and measures in terms of what it will buy. It is calculated using the following:

    Real Money = Nominal  MoneyPriced  Level\frac{Nominal\;Money} {Priced\;Level}


    Note: An xx % change in nominal money and price level will keep real money constant, other things remaining the same.

  2. Real GDP: The amount of money a household or firm plan to hold is based on the amount they are spending (consumer expenditure).

    If you think of it in terms of the whole economy, then the quantity of demand for money is based on aggregate expenditure (real GDP).

  3. Nominal Interest Rate: the nominal interest rate changes the amount of money people plan to hold because of opportunity costs.

    The higher the nominal interest rate, the higher the opportunity cost is for holding money.
    The lower the nominal interest rate, the lower the opportunity cost is for holding money.

    If the nominal interest rate is high, people would rather buy assets like savings bonds or Treasury bills to get the interest earned from them.

  4. Financial Innovation: The amount of money people plans to hold is influenced by technological changes, and new financial products. Some examples of financial innovations are daily interest checking deposits, credit cards and debit cards, and internet banking.

All these factors on money holding can be represented by using the Money Demand Curve.

Money Demand Curve

Demand for Money: is the relationship between the demand for quantity of real money and nominal interest rates (all other factors remaining the same).

The following graph illustrates the Money Demand Curve.

Money Demand & Supply


The higher the nominal interest, the lower the demand for the quantity of money.

The lower the nominal interest, the higher the demand for the quantity of money.

Shifts in Money Demand Curve: The demand for money can shift based on the increases and decreases of real GDP and financial innovation.

Case 1: If there is financial innovation or decrease in real GDP, then the money demand curve decreases, shifting to the left.

Money Demand & Supply


Case 2: If there is an increase in real GDP, then the money demand curve increases, shifting to the right.

Money Demand & Supply



Money Supply Curve

Supply for Money: is the relationship between the supply for quantity of real money and nominal interest rates (all other factors remaining the same), and is determined by banks and the Fed.

The following graph illustrates the Money Supply Curve.

Money Demand & Supply


The increase or decrease of nominal interest rate does not affect the quantity of money.

Shifts in Money Supply Curve: The Fed controls the supply of money.

Case 1: If the Fed increases the quantity of money, then the supply curve increases, shifting to the right,

Money Demand & Supply


Case 2: If the Fed increases the quantity of money, then the supply curve decreases, shifting to the left,

Money Demand & Supply



Short-Run & Long-Run Equilibrium

Short-Run Equilibrium: the equilibrium occurs at the intersection between the money demand curve and money supply curve.

Money Demand & Supply


This is where the demand for quantity of money is equal to supply for quantity of money.

Short-Run Effect from Shift of Money Supply: Suppose there is a shift in the supply curve. There are two cases of short-run equilibrium.

Case 1: The supply money curve shifts to the right.

Money Demand & Supply


People have more money than they plan to hold. With the extra money, people buy bonds. So, the demand for bonds increases and the prices of bonds increase, which decreases interest rates.

Case 2: the supply money curve shifts to the left.

Money Demand & Supply


People have less money than they plan to hold. To get more money, people sells bonds. So, the demand for bonds decrease and the price of bonds decrease, which increases interest rates.

Short-Run Effect from Shift of Money Demand: Suppose there is a shift in the demand curve. There are two cases of short-run equilibrium.

Case 1: The demand money curve shifts to the right.

Money Demand & Supply


People plan to hold more money. To get more money, people sell bonds. The demand for bonds decreases and the price of bonds decrease, which increases interest rates.

Case 2: the demand money curve shifts to the left.

Money Demand & Supply


People plan to hold less money. With the extra money held, people buy bonds. So, the demand for bonds increases and the prices of bonds increase, which decreases interest rates.

Long-Run Equilibrium: This occurs when the following conditions are met
  1. Actual inflation rate = expected inflation rate
  2. Real GDP = potential GDP.

In this case, the money market, loanable funds market, goods market, and labor markets are all in the long-run equilibrium.

Note: If the Fed increases the supply of money, then a new-long run equilibrium occurs but real GDP, employment, real money, and real interest does not change. Only the price level changes.