Financial Markets and the Economy
Read this chapter to build a foundation for understanding financial markets. The first section discusses the bonds and foreign exchange markets and the way they are connected through the interest rate. The second section builds the model of the money market and connects it to the other financial markets. Pay attention to how the connection is made between the financial markets and the overall economy by showing the effects on the equilibrium real GDP and the price level, using the model of aggregate demand and supply.
Demand, Supply, and Equilibrium in the Money Market
Equilibrium in the Market for Money
The money market is the
interaction among institutions through which money is supplied to
individuals, firms, and other institutions that demand money. Money
market equilibrium occurs at the interest rate at which the quantity of
money demanded is equal to the quantity of money supplied. Figure 10.8
"Money Market Equilibrium" combines demand and supply curves for money
to illustrate equilibrium in the market for money. With a stock of money
(M), the equilibrium interest rate is r.
Figure 10.8 Money Market Equilibrium
The market for money is in equilibrium if the quantity of money demanded is equal to the quantity of money supplied. Here, equilibrium occurs at interest rate r.