Question

On a graph draw the demand and supply curves for money. Explain why these curves are shaped the way they are. What forces push the value (or the purchasing power) of money to its equilibrium level?

Answer 1

The demand for money states that the total holding money by the households. The demand for money has a negative relationship between the rate of interest and demand for holding money. If the rate of interest is low then holding demand for money is high and vice-versa. Similarly, the supply of money determined by the central bank of the country.

In the diagram shows the demand and supply of money. The demand for money curve shows the downward sloping and supply of money curve shows completely inelastic. The short-run equilibrium is determined in the money market by the rate of interest. Suppose the rate of interest is above the equilibrium level then there is an excess supply of money in the economy. In this case, people hold more money, and this will reduce the rate of interest and moves again the equilibrium level.