The Money Market & Monetary Policy Part I

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
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 interestbearing asset. This is an
opportunity cost!
The demand for money…
As the interest
rate decreases
from r to r1, the
amount of money
held by people
increases from
MD to MD1.
Visual 4.1 Macroeconomics Unit 4
Factors affecting money demand…
Note that the
demand for
money also
depends on
price level and
on the level of
real GDP or real
For example, if
prices double,
people will need
twice as much
money to buy
goods and
Visual 4.2 Macroeconomics Unit 4
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…
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
•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
Morton, John S. and Rae Jean B. Goodman.
Advanced Placement Economics: Teacher
Resource Manual. 3rd ed. New York: National
Council on Economic Education, 2003. Print.