The Money Market & Monetary Policy Part I AP Macroeconomics

Where we came from…  In the previous lesson, we learned about the Federal Reserve System and how its actions relate to the money creation process.

Where are we going? In this lesson, we’ll bring together the demand for and supply of money in the money market. The effects of the Federal Reserve System’s monetary policy are integrated into the money market and linked to aggregate demand.

What are we doing today? We will practice manipulating the money market and understanding the impact of the Fed’s actions in this market.

People have a choice to make… How much of your wealth do you want to hold as money, and how much of it do you want to hold as interest-bearing assets (stock, bond, etc.)? The trade-off: If you hold onto money, you forego the interest you could earn on the money in an interest- bearing asset. This is an opportunity cost!

The demand for money… Visual 4.1 Macroeconomics Unit 4 As the interest rate decreases from r to r1, the amount of money held by people increases from MD to MD1.

Factors affecting money demand… Visual 4.2 Macroeconomics Unit 4 Note that the demand for money also depends on price level and on the level of real GDP or real income. For example, if prices double, people will need twice as much money to buy goods and services. Similarly, as income rises, so too does the demand for money.

What about supply? We need to add the money supply to the picture. Remember, the Fed determines the money supply through its tools… more_inflation_.html

This is the Money Market… Explore (in terms of shifts and equilibrium) changes in interest rate: What happens to the interest rate as prices rise? MD increases and the interest rate rises. As income increases? MD increases and the interest rate rises. As the money supply increases? Interest rate decreases. Visual 4.3 Macroeconomics Unit 4

And now… Some resources: Morton workbook: Activity 39

Works Cited Economics of Seinfeld. Krugman, Paul, and Robin Wells. Krugman’s Economics for AP. New York: Worth Publishers. Morton, John S. and Rae Jean B. Goodman. Advanced Placement Economics: Teacher Resource Manual. 3 rd ed. New York: National Council on Economic Education, Print. Reffonomics.