AP Macro mod 28

The Money Market

Overview

  • Focus on the concept of the money market, specifically Module 28.

Demand for Money

Definition

  • Demand for money refers to the total amount of money (M1) that people want to hold at any given time.

M1 Money

  • M1 includes:

    • Cash

    • Checkable deposits (money in checking accounts)

  • Important to note that economic demand is not merely wanting but the actual amount held for transaction and asset purposes.

Reasons for Holding Money

Transaction Demand for Money

  • Individuals keep money for everyday transactions, serving as a medium of exchange.

Asset Demand for Money

  • Money is held as a less risky asset compared to stocks, bonds, and real estate.

  • Opportunity Cost: Interest lost by not investing money in interest-earning assets.

Impact of Interest Rates on Demand

Interest Rates and Quantity Demand

  1. When Interest Rates Increase:

    • Quantity demanded of money falls.

    • Preference shifts towards earning assets instead of holding cash.

  2. When Interest Rates Decrease:

    • Quantity demanded of money increases.

    • Less incentive to convert cash into interest-earning assets.

Relationship

  • There is an inverse relationship between interest rates and the quantity of money demanded.

Money Demand Shifters

  • Factors that shift the demand curve for money include:

    1. Changes in price level

    2. Changes in income

    3. Changes in technology

Money Market Practice Questions

Example Questions:

  1. The transaction demand for money is associated with:

    • (A) store of value

    • (B) standard unit of account

    • (C) measure of value

    • (D) medium of exchange

    • (E) standard of deferred payment

  2. The amount of money the public wants to hold in cash is affected by:

    • (A) unaffected by interest rates or prices

    • (B) increases if interest rates increase

    • (C) decrease if interest rates increase

    • (D) increases if price level decreases

    • (E) decrease if the price level remains constant

Supply of Money

Key Points about Money Supply:

  1. Set by the Federal Reserve (Fed); changes only through Fed actions.

  2. Changes in money supply do not mean the physical printing of money, but adjustments in availability through banks.

  3. Discuss the graph that represents supply vs. demand of money.

Money Supply Changes

  1. Increasing the Money Supply:

    • Temporary surplus occurs leading to lower interest rates.

    • This results in increased investment and aggregate demand (AD).

  2. Decreasing the Money Supply:

    • Temporary shortage leads to higher interest rates.

    • Results in decreased investment and AD.

The Federal Reserve (Fed)

Background

  • Established in 1913 to regulate banks and maintain public confidence in the financial system.

Conclusion

  • Understanding the money market involves grasping the concepts of demand and supply of money, the impact of interest rates, and the role of the Federal Reserve.