AP Economics

Mr. Bernstein

Module 28: The Money Market

March 3, 2015

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AP EconomicsMr. Bernstein

The Money Market• Objectives - Understand each of the following:• What the money demand curve is• Why the liquidity preference model determines the

interest rate in the short run

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AP EconomicsMr. Bernstein

The Opportunity Cost of Holding Money• You could be earning interest on the money!• Opportunity Cost therefore changes with interest

rates• We use short-term rates as the cost• When we use the term money, we consider it to mean

funds that will be used for transactions in the short term, not funds to be invested in longer term projects

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AP EconomicsMr. Bernstein

The Money Demand Curve• Y axis is Nominal

Rates, not Real• Downward sloping• Higher rates attract

funds and reducethe demand for cash

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AP EconomicsMr. Bernstein

Shifts in the Money Demand Curve• Shifts make money

more desirable atany interest rate

• D Price Levels• proportional

• D Real GDP• D Banking Technology

• ie ATMs reduce demand

• D Banking Institutions• Instability reduces demand

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AP EconomicsMr. Bernstein

Equilibrium Interest Rate: Liquidity Preference Model• Assumes fixed MS• At higher interest rates,

individuals prefer CDsto money (cash), so demand for cash falls

• At lower interest rates,demand for cash rises

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AP EconomicsMr. Bernstein

Two Models of the Interest Rate• Liquidity Preference and Loanable Funds Market