Download The Money Demand Curve

Module 28: Money Market
The Demand for Money: Why do want to have money in your pocket?
The Opportunity Cost of Holding Money: Having money in your
pocket makes it easy to make purchases. The price is you don’t earn
interest on that $$.
Let’s say Megan puts $100 in a 12-month CD at 5 % interest. A CD is not
very liquid! If she chooses to hold the cash instead, it comes at an
opportunity cost of $5.
50%? .5 %?
The Money Demand Curve: Opportunity cost of holding money in the
short term is the short-term interest rate.
Since there is basically no inflation in the short term, we can say that
the nominal interest rate = real interest rate.
It is logical then to say that as the interest rate rises, the demand for
money will fall, thus giving us a downward-sloping demand curve.
Shifts of the Money Demand Curve:
1. Changes in the APL: Higher prices will increase the demand for $.
They are actually proportional, if the APL  by 20 %, then the
quantity of money demanded will  by 20 %.
2. Changes in Real GDP: As the economy gets stronger, real incomes
& real GDP rise. The more we buy, the larger the quantity of money
we will need to hold. Real GDP , Money Demand will shift to the
right.
3. Changes in technology: In general, advances in information
technology have reduced the demand for money.
Ex. If there was an ATM on every corner and in every retail store,
we might tend to carry less cash!
4. Changes in Institutions: Regulations that make it more attractive
to keep money in banks will reduce the demand for money.
Ex. If the FDIC ceases to exist…
Money and Interest Rates: The Fed focuses it’s tools of monetary
policy to achieve a target level for the federal funds rate.
The Equilibrium Interest Rate: The Money Supply (MS) is going to be
set by the Fed and is independent of the interest rate so it will be vertical.
We can look at the option of having $ in a CD vs. holding in your pocket
on the Money Market model on the board: