the money demand curve to the right, leading to an increase in the interest rate. *Shifts in Money Supply money supply increases, a shift in the vertical money supply curve from M s1 to M s2 . Quantity supplied exceeds quantity demanded. When the money supply increases. The economy moves along the money demand curve to a larger quantity of money demanded at a lower level of interest rates, i 2 . At lower interest rates, people will be willing to hold larger cash balances. Figure 10.2: An increase in the money supply *An increase in the money supply shifts the money supply from M s1 to M s2 . The result is a decline in interest rates from i 1 to i 2 as households increase their cash balances and banks increase their lending. 29. The transactions demand for money depends on both the price level and real income. Correct. The transactions demand for money does depends on both the price level and real income. 30. "Fill in the blank" question: When interest rates rise, the transactions demand for money usually decreases . Correct. When interest rates rise, the transactions demand for money decreases. 31. If the market for money is in equilibrium, then the demand for money must be equal to the supply of money.
Correct. If the market is in equilibrium the demand for money will be equal to the supply of money. 32. An increase in interest rates, ceteris paribus , will cause the money demand curve to do which of the following? It only causes a movement along the demand for money curve. Correct. A change in interest rates, ceteris paribus, will only cause a movement along the money demand curve. 33. True or false. The interest rate is determined where the money market is in equilibrium. True Correct. The price of money is the interest rate and that is determined where the money demand curve intersects the money supply curve. 34. True or false. At lower interest rates, people will not be willing to hold larger cash balances. False Correct. When interest rates are lower, people will hold more cash balances. *Money Market, Aggregate Demand, and Economic Growth *Money Demand, Money Supply, and Aggregate Demand The equation of exchange: One of the reasons why the aggregate demand curve slopes downward is based on the equation of exchange. If M s × V = P × Y , this relationship implies that a given money supply will equalize various combinations of P (price level) and Y (real output). In terms of the aggregate demand curve, the equation of exchange implies that a fixed money supply (M s ) combined with a stable velocity ( V ) will yield a constant value of nominal GDP ( P x Y ). However, for any given nominal GDP, various combinations of P and Y are possible. For example, the combinations of money supply and velocity that resulted in total spending of $6,000 could imply a price level of $1 and real output of 6,000 units, or a price level of $4 and real output of 1,500 units. An increase in the money supply would permit a higher P with the same Y or a higher Y with the same P , or higher levels of both.