AP Economics
Mr. Bernstein
Module 28:
The Money Market
February 2016
AP Economics
Mr. Bernstein
The Money Market
• Objectives - Understand each of the following:
• What the money demand curve is
• Why the liquidity preference model determines the
interest rate in the short run
2
AP Economics
Mr. Bernstein
The Opportunity Cost of Holding Money
• You could be earning interest on the money!
• Opportunity Cost therefore changes with interest
rates
• We use short-term rates as the cost
• When we use the term money, we consider it to mean
funds that will be used for transactions in the short
term, not funds to be invested in longer term projects
3
AP Economics
Mr. Bernstein
The Money Demand Curve
• Y axis is Nominal
Rates, not Real
• Downward sloping
• Higher rates attract
funds and reduce
the demand for cash
4
AP Economics
Mr. Bernstein
Shifts in the Money Demand Curve
• Shifts make money
more desirable at
any interest rate
• D Price Levels
• proportional
• D Real GDP
• D Banking Technology
• ie ATMs reduce demand
• D Banking Institutions
• Instability reduces demand
5
AP Economics
Mr. Bernstein
Equilibrium Interest Rate: Liquidity Preference
Model
• Assumes fixed MS
• At higher interest rates,
individuals prefer CDs
to money (cash), so
demand for cash falls
• At lower interest rates,
demand for cash rises
6
AP Economics
Mr. Bernstein
Two Models of the Interest Rate
• Liquidity Preference and Loanable Funds Market
7