Demand, Supply, and Equilibrium in the Money Market
Key Takeaways
- People hold money in order to buy goods and
services (transactions demand), to have it available for contingencies
(precautionary demand), and in order to avoid possible drops in the
value of other assets such as bonds (speculative demand).
- The
higher the interest rate, the lower the quantities of money demanded for
transactions, for precautionary, and for speculative purposes. The
lower the interest rate, the higher the quantities of money demanded for
these purposes.
- The demand for money will change as a result of a
change in real GDP, the price level, transfer costs, expectations, or
preferences.
- We assume that the supply of money is determined by
the Fed. The supply curve for money is thus a vertical line. Money
market equilibrium occurs at the interest rate at which the quantity of
money demanded equals the quantity of money supplied.
- All other
things unchanged, a shift in money demand or supply will lead to a
change in the equilibrium interest rate and therefore to changes in the
level of real GDP and the price level.