Macroeconomics

‭Equilibrium in the Money Market‬ ‭Equilibrium‬ ‭in‬ ‭the‬ ‭money‬ ‭market‬ ‭is‬ ‭achieved‬ ‭where‬ ‭money‬ ‭demand‬ ‭is‬ ‭equal‬ ‭to‬ ‭money‬ ‭supply.‬ ‭Graphically,‬‭this‬‭is‬‭illustrated‬‭by‬‭the‬‭intersection‬‭of‬‭the‬‭money‬‭demand‬‭curve‬‭(Md)‬‭and‬‭the‬‭money‬‭supply‬ ‭curve (Ms).‬

‭In‬‭this‬‭money‬‭market‬‭graph,‬‭equilibrium‬‭is‬‭achieved‬‭at‬‭point‬‭X.‬‭At‬‭this‬‭point,‬‭the‬‭equilibrium‬‭level‬‭of‬‭the‬ ‭nominal interest rate is illustrated by i ₑ and the equilibrium quantity of money by M ₑ .‬ ‭This‬‭graph‬‭demonstrates‬‭how‬‭the‬‭Fed’s‬‭actions‬‭and‬‭the‬‭banking‬‭system‬‭in‬‭general‬‭determine‬‭the‬‭market‬ ‭interest‬ ‭rate.‬ ‭When‬ ‭money‬ ‭supply‬ ‭increases‬ ‭(shifts‬ ‭from‬ ‭Ms‬ ‭to‬ ‭Ms₁),‬ ‭the‬ ‭nominal‬ ‭interest‬ ‭rate‬ ‭decreases‬ ‭(from‬ ‭i ₑ ‬ ‭to‬ ‭i₁)‬ ‭,‬ ‭which‬ ‭means‬ ‭that‬ ‭the‬ ‭“price”‬ ‭of‬ ‭money‬ ‭has‬ ‭decreased.‬ ‭Conversely,‬ ‭when‬ ‭money‬ ‭supply‬ ‭decreases‬ ‭(shifts‬‭from‬‭Ms‬‭to‬‭Ms₂),‬‭the‬‭interest‬‭rate‬‭increases‬‭(from‬‭i ₑ ‬‭to‬‭i₂)‬ ‭,‬‭meaning‬ ‭that‬‭the‬‭price‬‭of‬‭money‬‭has‬‭increased‬‭(at‬‭higher‬‭interest‬‭rates,‬‭the‬‭opportunity‬‭cost‬‭of‬‭holding‬‭money‬‭is‬ ‭higher, and vice versa).‬

‭Alternatively,‬ ‭a‬‭shift‬‭of‬‭the‬‭money‬‭demand‬‭curve‬‭only‬‭affects‬‭the‬‭nominal‬‭interest‬‭rate‬ ‭when‬‭money‬ ‭supply‬ ‭remains‬ ‭unchanged.‬ ‭An‬ ‭increase‬ ‭in‬ ‭money‬ ‭demand‬ ‭(from‬‭Md‬‭to‬‭Md₁)‬‭increases‬‭the‬‭nominal‬ ‭interest‬ ‭rate‬ ‭(from‬ ‭i ₑ ‬ ‭to‬ ‭i₁)‬ ‭,‬ ‭whereas‬ ‭a‬ ‭decrease‬ ‭in‬ ‭money‬ ‭demand‬ ‭(from‬ ‭Md‬ ‭to‬ ‭Md₂)‬ ‭reduces‬ ‭the‬ ‭nominal interest rate (from i ₑ to i₂)‬ ‭.‬

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