1. Money Supply/Demand

2. The Equilibrium Interest Rate
[at “E”, money supplied ($200) = money demanded ($200)]
The Equilibrium Interest Rate
The Dm curve represents the quantity of money
people are willing to hold at various interest rates.
7.5 5
2.5 MS Dm
Notice nominal interest not real E
Nominal Interest Rate
Billion
Money Market
The point at which the quantity of money demanded equals the quantity of money supplied determines the equilibrium interest rate in the economy [in this case, 5%].

3. Figure 1 How the Supply and Demand for Money Determine the Equilibrium Price Level
Value of
Price
Money,
Quantity fixed
by the Fed
Money supply 1 / P
Level, P
(High) 1
Money
demand 1
(Low) 3 /
1.33 4 A 1 / 2 2
Equilibrium
value of
money
Equilibrium
price level 1 / 4 4
(Low)
(High)
Quantity of
Money

4. Demand For Money [Demand for “cash in hand”]
For Daily, Weekly, & Monthly Transactions
Mortgage/rent
Utilities
Gas
Food
Emergency money
Tuition for kids
Christmas gifts
Transactions
Demand, Dt M1
Independent of
interest rate
Direct with
Nominal Y
Medium of
Exchange M1
Nominal Interest Rate
Money demanded (bil.) Dt 10
7.5 5
2.5
Valentine candy for wife
Gift for the girlfriend
We keep this transaction money(M1)
in our wallet, under our mattress, or
in our checking accounts.

5. Rate of interest, i (percent)
THE Total DEMAND FOR MONEY
Transactions
Demand, Dt
[“make exchanges”]
Asset
Demand, Da
[“hold wealth”] + =
Total demand
for money, Dm
Da [M2] – store of value money
Money that we don’t need for daily, weekly,
or monthly transactions. We will invest more
of it the higher the interest rate. We will hold
less because the opportunity cost increases.
“Walking around”
money M1
Rate of interest, i (percent)
Amount of money
demanded (billions) 10
7.5 5
2.5 Da
Nominal Interest Rate
Amount of money
demanded (billions) Dt 10
7.5 5
2.5 Dt
Independent
of the
interest
rate Da
10% 8% 6% 4% 2%
Interest Rate
Opportunity Cost
Da [hold less]
Da [hold more]
“I’m losing more interest, the higher the I.R.”
CDs or 5%
Da varies inversely
with the interest rate. 1%

6. Money Demand
This is a hard one to understand!!! Demand for money is not the need for money. It is how much you will choose to carry (in your pocket)
It is very critical you understand the distinction.

7. What if you get a Raise in Income=you demand more money-nominal interest rates go up-inflation goes down!
Value of
Price
Money, M1
MS1 1 / P
Level, P
Money
demand
(High) 1
Money
demand 1
(Low)
Nominal Interest Rates 3 /
1.33 4 A 1 / 2 2 B 1 / 4 4
(Low)
(High)
Quantity of
Money

8. It makes since if you think about it
It makes since if you think about it. Because you demand more money interest rates go up to attract your money to the banks to save. Because interest rates go up people put more money in the bank instead of caring it around which means people are spending less money which means the prices on things will go down.

9. Figure 2 An Increase in the Money Supply
Value of
Price
Money, M1
MS1 M2
MS2 1 / P
Level, P
(High) 1
Money
demand 1
(Low)
1. An increase
in the money
supply . . . 3 /
1.33 4
decreases
the value of
mone
y . . . 3.
. . . and
increases
the price
level. A 1 / 2 2 B 1 / 4 4
(Low)
(High)
Quantity of
Money

10. The Equilibrium Interest Rate
7.5 5
2.5 MS Dm E
Nominal Interest Rate
Billion
Money Market

11. Money Demand 1.
The interest rate: Higher Interest rates make you want to hold less money.
Lower Interest rates make you want hold more money.
(Like a Dot to Dot) 2.
High Inflation-more demand for money
Low inflation-lower demand for money
3. Income-more income more demand for money-you buy more stuff
Less income-you demand less money-you don’t buy as much stuff.

12. Inflation make money demand go up!
High Inflation means you need more money in your pocket to spend since the prices on things have gone up. In other words you have to carry more in you pocket to buy stuff.
Lower inflation does the opposite.

13. Higher incomes
Higher income make people buy more stuff. Therefore they need more in their pockets.
Lower incomes make people buy less so they don’t carry any in their pocket because they don’t have any money anyway.
This is a hard one to understand!!! Demand for money is not the need for money. It is how much you will choose to carry (in your pocket)

14. The Equilibrium Interest Rate
[at “E”, money supplied ($200) = money demanded ($200)] Dm
MS1
10%
7.5% 5%
Excess supply of money
Nominal Interest Rate E
Billion
Money Market
At a 7.5% interest rate, the amount of money in circulation is more than households and firms wish to hold. They will attempt to reduce their money holdings by buying bonds.

15. The Equilibrium Interest Rate
[at “E”, money supplied ($200) = money demanded ($200)]
MS1 Dm 10
7.5 5
2.5
Excess supply of money
Nominal Interest Rate E
Excess demand for money
Billion
Money Market
At 2.5%, households don’t have enough money to facilitate ordinary transactions. They will sell bonds and put the money in their checking accounts.

16. Money Supply, Money Demand, and Monetary Equilibrium
The money supply is a policy variable that is controlled by the Fed.
Through instruments such as open-market operations, the Fed directly controls the quantity of money supplied.
Money demand has several determinants, including interest rates and the average level of prices in the economy.
Bullet 2: Mankiw has removed the word, “directly”

17. Money Supply, Money Demand, and Monetary Equilibrium
People hold money because it is the medium of exchange.
The amount of money people choose to hold depends on the prices of goods and services.
In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply.

18. The Effects of a Monetary Injection
The Quantity Theory of Money
How the price level is determined and why it might change over time is called the quantity theory of money.
The quantity of money available in the economy determines the value of money.
The primary cause of inflation is the growth in the quantity of money.

19. Velocity and the Quantity Equation
The velocity of money refers to the speed at which the typical dollar bill travels around the economy from wallet to wallet.
V = (P  Y)/M
where: V = velocity
P = the price level
Y = the quantity of output
M = the quantity of money

20. The real interest rate stays the same.
The Fisher Effect
The Fisher effect refers to a one-to-one adjustment of the nominal interest rate to the inflation rate.
According to the Fisher effect, when the rate of inflation rises, the nominal interest rate rises by the same amount.
The real interest rate stays the same.
The equation of the fisher effect must appear here or on a new next slide:
“Nominal interest rate = real interest rate + inflation rate”

21. Figure 5 The Nominal Interest Rate and the Inflation Rate
Percent
(per year) 15 12
Nominal interest rate 9 6
Inflation 3
1960
1965
1970
1975
1980
1985
1990
1995
2000

22. THE COSTS OF INFLATION A Fall in Purchasing Power?
Inflation does not in itself reduce people’s real purchasing power.

23. THE COSTS OF INFLATION Shoeleather costs Menu costs
Relative price variability
Tax distortions
Confusion and inconvenience
Arbitrary redistribution of wealth

24. Shoeleather Costs
Shoeleather costs are the resources wasted when inflation encourages people to reduce their money holdings.
Inflation reduces the real value of money, so people have an incentive to minimize their cash holdings.
Less cash requires more frequent trips to the bank to withdraw money from interest-bearing accounts.

25. Shoe-leather Costs
The actual cost of reducing your money holdings is the time and convenience you must sacrifice to keep less money on hand.
Also, extra trips to the bank take time away from productive activities.

26. Menu Costs
Menu costs are the costs of adjusting prices.
During inflationary times, it is necessary to update price lists and other posted prices.
This is a resource-consuming process that takes away from other productive activities.