The Demand for Money Chapter 8

2 ©1999 South-Western College Publishing Figure 8.1 The Balance Sheet of Households and Firms Households AssetsLiabilities Corporate bonds P B B MoneyM WW W Net worth AssetsLiabilities Firms Capital stock PK PK Corporate bonds P B B PBBPBB

3 ©1999 South-Western College Publishing Figure 8.2 How the Household Allocates Wealth M/P (Real money balances) (M/P) * (M/P) 1 Y (Real income) Y MAX Y*Y* Y1Y1 i U1U1 U2U2 Every combination of real balances and real income on the same indifference curve yields equal utility. Indifference curves further to the northeast represent combinations that yield higher utility.

4 ©1999 South-Western College Publishing Figure 8.3 How Equilibrium is Established Y (M S /P) 1 = (M D /P) 1 (M S /P) 2 = (M D /P) 2 i1i1 i2i2 E2E2 E1E1 A

5 ©1999 South-Western College Publishing Box 8.1A Velocity of circulation (left scale); Units: 1/years Interest rate (right scale); Units: % per year Comparing the Quantity Theory of Money and the Modern Theory of the Demand for Money Panel A

6 ©1999 South-Western College Publishing Box 8.1B Correlation coefficient = 0.74 Interest rate Velocity of circulation Comparing the Quantity Theory of Money and the Modern Theory of the Demand for Money Panel B

7 ©1999 South-Western College Publishing Figure 8.4A Deriving the LM Curve i (Interest rate) i1i1 i2i2 Y (Income) Y1Y1 Y*Y* Y2Y2 Panel A LM A B

8 ©1999 South-Western College Publishing Figure 8.4B Deriving the LM Curve i (Interest rate) (Quantity of money demanded and supplied) MS/PMS/P Panel B L, M S /P L(Y1)L(Y1) L(Y2)L(Y2) Two money demand curves

9 ©1999 South-Western College Publishing Figure 8.5A Y (Income) How an Increase in the Money Supply Shifts the LM Curve i (Interest rate) A B Panel A Y1Y1 LM(M 1 /P) LM(M 2 /P) i2i2 i1i1

10 ©1999 South-Western College Publishing Figure 8.5B L, M S /P (Money demand and supply) How an Increase in the Money Supply Shifts the LM Curve i (Interest rate) M1/PM1/PM2/PM2/P A B Panel B L(Y1)L(Y1)

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