Unit 4 - Money Demand/Supply/Shifters (3-9-16)

• Demand for money has an inverse relationship between nominal interest rates and quantity of money demanded

1. What happens to quantity demanded of money when interest rates increase?

• Quantity demanded falls because individuals would prefer to have interest assets instead of borrow liabilities 

2. What happens to quantity demanded when interest rates decrease?

• Quantity demanded increases, there is no incentive to convert cash into interest earning assets.

Money Demand Shifters:

1. Changes in price level
2. Changes in income
3. Changes in taxation that affects investment

Money Supply:

• If FED increases money supply, a temporary surplus of money will occur at 5% interest. This surplus will cause interest rate to fall to 2%

How does this affect AD?
Increase money supply --> Decrease interest rate --> Increase investment --> Increase AD

Decrease money supply --> Increase interest rate --> Decrease investment --> Decrease AD