Transcript View Point Slide Show Lesson 10-2

Lesson 10-2
Demand, Supply, and Equilibrium in the Money Market
The Demand for Money
The demand for money is the relationship between the quantity of
money people want to hold and the factors that determine that
quantity.
Motives for Holding Money
The transactions demand for money is money people hold to pay
for goods and services they anticipate buying.
The precautionary demand for money is the money people hold
for contingencies.
The speculative demand for money, according to John Maynard
Keynes, is the money held in response to concern that bond prices
and the prices of other financial assets might change.
Interest Rates and the Demand for Money
The quantity of money people hold for all the
motives is likely to vary with the interest rates they
can earn from alternative assets such as bonds.
When interest rates rise, the quantity of money
held falls. When interest rates fall, the quantity of
money held rises.
People can satisfy their transactions and
precautionary demands for money with various
combinations of money and bond funds (or liquid
investments).
Implications of the bond fund approach are as
follows:
A household is more likely to adopt a bond fund
strategy when the interest rate is higher.
People are more likely to use a bond fund strategy
when the cost of transferring funds is lower.
Speculative demand for money depends upon the
expected future price of bonds.
The lower the interest rates, the higher bond prices
and the greater the likelihood that investors will
expect bond prices to fall.
The Demand Curve for Money
The demand curve for money shows the quantity of
money demanded at each interest rate, all other
things unchanged.
A rise in the interest rate lowers the quantity of
money demanded. A fall in the interest rate raises the
quantity of money demanded.
Other Determinants of the Demand for Money
Real GDP
The price level
Expectations
T
Transfer costs
Preferences
Household attitudes toward risk affect money
demand.
Household attitudes toward the importance of
cash balances on hand affect money demand.
The Supply of Money
The supply curve of money shows the relationship
between the quantity of money supplied and the
market interest rate, all other determinants of supply
unchanged.
The Fed is able to control the total quantity of
reserves in the banking system through open-market
operations.
We assume that the money supply is a fixed multiple
of reserves.
The supply curve of money as a function of the
interest rate is therefore a vertical line.
Equilibrium in the Market for Money
The money market is the interaction among
institutions through which money is sup-plied to
individuals, firms, and other institutions that demand
money.
Money market equilibrium occurs at the interest rate
at which the quantity of money demanded is equal to
the quantity of money supplied.
Money market equilibrium can be illustrated
graphically.
Changes in Money Demand
A decrease in money demand, all other things unchanged, shifts
the money demand curve to the left and results in a new money
market equilibrium with a lower interest rate.
A decrease in money demand means that people want more bonds
and less money thereby driving up the price of bonds and lowering
the interest rate.
An increase in money demand means that people want to hold
more money and fewer bonds thereby driving down the price of
bonds and raising the interest rate.
An increase in money demand causes the money demand curve to
shift to the right resulting in a new equilibrium with a higher interest
rate.
Changes in the Money Supply
An increase in the money supply shifts the money supply curve to
the right resulting in a new equilibrium with a lower interest rate.
An increase in the money supply gives people more money than
they want and causes them to buy bonds which drives the price of
bonds up and the interest rate down.
A decrease in the money supply shifts the money supply curve to
the left resulting in a new equilibrium with a higher interest rate.
A decrease in the money supply gives people less money than they
want and causes them to sell bonds which drives the price of bonds
down and the interest rate up.
The Fed sells bonds to reduce the money supply and buys bonds
to increase the
money supply.