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Unit 4: Money and Monetary Policy 1. The Money Market (Supply and Demand for Money) 2.

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Presentation on theme: "Unit 4: Money and Monetary Policy 1. The Money Market (Supply and Demand for Money) 2."— Presentation transcript:

1 Unit 4: Money and Monetary Policy 1

2 The Money Market (Supply and Demand for Money) 2

3 The Demand for Money At any given time, people demand a certain amount of liquid assets (money) for everyday purchases The Demand for money shows an inverse relationship between nominal interest rates and the quantity of money demanded 1. What happens to the quantity demanded of money when interest rates increase? Quantity demanded falls because individuals would prefer to have interest earning assets instead 2. What happens to the quantity demanded when interest rates decrease? Quantity demanded increases. There is no incentive to convert cash into interest earning assets 3

4 Nominal Interest Rate (ir) Quantity of Money (billions of dollars) 20% 5% 2% 0 D Money Inverse relationship between interest rates and the quantity of money demanded 4 The Demand for Money

5 Quantity of Money (billions of dollars) 20% 5% 2% 0 D Money What happens if price level increase? 5 The Demand for Money D Money1 Money Demand Shifters 1.Changes in price level 2.Changes in income 3.Changes in taxation that affects investment Nominal Interest Rate (ir)

6 The Demand for Money At any given time, people demand a certain amount of liquid assets (money) for everyday purchases The Demand for money shows an inverse relationship between nominal interest rates and the quantity of money demanded 1. What happens to the quantity demanded of money when interest rates increase? Quantity demanded falls because individuals would prefer to have interest earning assets instead 2. What happens to the quantity demanded when interest rates decrease? Quantity demanded increases. There is no incentive to convert cash into interest earning assets 6

7 200 D Money S Money The FED is a nonpartisan government office that sets and adjusts the money supply to adjust the economy This is called Monetary Policy. The U.S. Money Supply is set by the Board of Governors of the Federal Reserve System (FED) 7 The Supply for Money 20% 5% 2% Quantity of Money (billions of dollars) Interest Rate (ir)

8 Monetary Policy 8 When the FED adjusts the money supply to achieve the macroeconomic goals

9 If the FED increases the money supply, a temporary surplus of money will occur at 5% interest. The surplus will cause the interest rate to fall to 2% Increasing the Money Supply Increase money supply Decreases interest rate Increases investment Increases AD DMDM SMSM 10% 5% 2% Quantity of Money (billions of dollars) Interest Rate (ir) How does this affect AD? 250 S M1

10 If the FED decreases the money supply, a temporary shortage of money will occur at 5% interest. The shortage will cause the interest rate to rise to 10% Decreasing the Money Supply Decrease money supply Increase interest rate Decrease investment Decrease AD DMDM SMSM 10% 5% 2% Quantity of Money (billions of dollars) Interest Rate (ir) How does this affect AD? 150 S M1

11 11

12 Video: The FED Today 12

13 2007B Practice FRQ 13

14 2007B Practice FRQ 14

15 2007B Practice FRQ 15


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