4.5 The Money Market

a. Define (using graphs as appropriate) the money market, money demand, and money supply. b. Explain (using graphs as appropriate) the relationship between the nominal interest rate and the quantity of money demanded (supplied).

• The demand for money shows the inverse relationship between the nominal interest rate and the quantity of money people want to hold.
• Given a monetary base determined by a country’s central bank, money supply is independent of the nominal interest rate.
• Enduring understanding MKT-3: In the money market, demand for and supply of money determine the equilibrium nominal interest rate and influence the value of other financial assets.

Define (using graphs as appropriate) equilibrium in the money market.

• In the money market, equilibrium is achieved when the nominal interest rate is such that the quantities demanded and supplied of money are equal.
• Enduring understanding MKT-3: In the money market, demand for and supply of money determine the equilibrium nominal interest rate and influence the value of other financial assets.

Explain (using graphs as appropriate) how nominal interest rates adjust to restore equilibrium in the money market.

• Disequilibrium nominal interest rates create surpluses and shortages in the money market. Market forces drive nominal interest rates toward equilibrium.
• Enduring understanding MKT-3: In the money market, demand for and supply of money determine the equilibrium nominal interest rate and influence the value of other financial assets.

a. Explain (using graphs as appropriate) the determinants of demand and supply in the money market. b. Explain (using graphs as appropriate) how changes in demand and supply in the money market affect the equilibrium nominal interest rate.

• Factors that shift the demand for money, such as changes in the price level, and supply of money, such as monetary policy, change the equilibrium nominal interest rate.
• Enduring understanding MKT-3: In the money market, demand for and supply of money determine the equilibrium nominal interest rate and influence the value of other financial assets.