Question

What is the basic determinant of (a) the transactions demand and (b) the asset demand for money?  Explain how these two demands can be combined graphically to determine total money demand.  How is the equilibrium interest rate in the money market determined?  How might (a) the expanded use of credit cards, (b) a shortening of worker pay periods, and (c) an increase in nominal GDP each independently affect the transactions demand for money, and the equilibrium interest rate?

Answer 1

(a) The level of nominal GDP. The higher this level, the greater

the amount of money demanded for transactions. (b) The interest

rate. The higher the interest rate, the smaller the amount of

money demanded as an asset.

On a graph measuring the interest rate vertically and the

amount of money demanded horizontally, the two demands for

the money curves can be summed horizontally to get the total

demand for money. This total demand shows the total amount of

money demanded at each interest rate. The equilibrium interest

rate is determined at the intersection of the total demand for

money curve and the supply of money curve.

(a) Expanded use of credit cards: transaction demand for

money declines; total demand for money declines; interest rate

falls. (b) Shortening of worker pay periods: transaction demand

for money declines; total demand for money declines; interest

rate falls. (c) Increase in nominal GDP: transaction demand for

money increases; total demand for money increases; interest rate

rises.