1. Unit Four:
The Money Market

2. Goals Correctly label a money market graph.
Identify shifts in the demand and supply of money and how that impacts interest rates.

3. I. The Money Demand Curve
The Money Market Graph
Measures the relationship between short-term interest rates and the quantity of money in M1.
The Demand for Money
Inverse relationship with price and quantity.
The lower the interest rate, the smaller the opportunity cost of keeping money as M1 with no interest.
The cost of turning M1 into assets is high, therefore interest must be higher to incentivize investments.

4. I. The Money Demand Curve
Inflation increases the demand for money.
Demand for money will increase/decrease at the same rate as changes in price level.
Changes in Aggregate Price Level
Money facilitates purchases.
The higher the GDP the more purchases we make, the more money we demand.
Changes in Real GDP
New technology in banking changes the velocity of money.
Ex. ATMs, Credit Cards, and Debit Cards
Changes in Technology
Regulations in banking changes liquidity.
Ex. Elimination of Regulation Q (interest on checkable deposits)
Changes in Institutions

5. II. Money Supply Liquidity Preference Model of the Interest Rate
Interest rates are determined by the supply and demand for money.
Money Supply
Quantity of money supplied by the Federal Reserve.
The Fed chooses the level of money supply that it believes will achieve the target interest rate.

6. The aggregate price level
III. Review
A change in which of the following will shift the money demand curve?
The aggregate price level
Real GDP
The interest rate
I only
II only
III only
I and II only
I, II, and III D

7. III. Review
2. Which of the following will decrease the demand for money?
An increase in the interest rate
Inflation
An increase in real GDP
An increase in the availability of AMTs
The adoption of Regulation Q D

8. III. Review
3. The quantity of money demanded rises (that is, there is a movement along the money demand curve) when
The aggregate price level increases
The aggregate price level falls
Real GDP increases
New technology makes banking easier
Short-term interest rates fall E

9. III. Review
Draw three correctly labeled graphs of the money market. Show the effect of each of the following three changes on a separate graph.
The aggregate price level increases.
Real GDP falls.
There is a dramatic increase in online banking.