The Money Market
Module 28
The Money Market
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
• Just as we have a market for
automobiles or oranges, we also have
a market for money
• This market represents the amount of
money people want to hold (M1) as
opposed to investing.
The Demand for Money
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
• How much money people want to
hold (money demand) is going to be
influenced by the interest rate
• As the interest rate increases, the
opportunity costs of holding money
(rather than investing) become
greater
The Money Demand Curve
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
Shifts in Money Demand
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
Shifts in Money Demand
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
• Changes in aggregate price level
– If prices increase, people will need more
money to cover spending
• Changes in GDP
– As GDP increases, people will spend
more thus requiring more money
Shifts in Money Demand
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
• Changes in technology
– As technology allows purchases to be
made without the use of money, money
demand goes down
• Changes in Institutions/Regulations
– Some regulations/practices might make it
more attractive for people to keep
money in checking accounts rather than
investing
Money & Interest Rates
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
• Interest rates will be influenced by
shifts in both money demand and
money supply
• The equilibrium point determines the
effective interest rate
Money Supply
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
Liquidity Preference Model
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
• This method of determining the
interest rate is known as the liquidity
preference model
• Interest rates will change with money
demand and money supply
• Importantly, this model deals with
nominal interest rates. Long term
interest rates can behave differently
Examples
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
What will happen to the money
demand, money supply and nominal
interest rate if
1. The Federal Reserve sells Treasury
Bonds
2. The Price Level falls
Examples
1) The Demand for
Money
- Opportunity Costs
- Money Demand
Curve
- Shifts in Money
Demand
2) Money & Interest
Rates
- Money Supply
- Liquidity Preference
Model
3) Examples
• What will happen to the money
supply and nominal interest rate if
1. The Federal Reserve lowers the
reserve rate
2. The economy enters recession