Villa, Monique
Williams, Ronald
Econ 1AH
April 22nd, 2010
Chapter 12: The Supply & Demand for Money (Pages 267-284)
Chapter twelve deals with the relationship between monetary policy and interest rates as it relates to the supply and demand for money. In this chapter, money is referred to as stock.   As opposed to other “M2” assets, people prefer to hold certain quantities of money for particular periods of time for its high liquidity. Demand for money is based on people’s income, considering people with low income have too many expenses to withhold amounts of money while the wealthy can elect to hold assets in the highly liquid form of money as opposed to other assets. The stock of money people choose to hold varies proportionately to their level of income. This ratio of nominal domestic income to the stock of money is termed the income velocity of money. By making the choice to maintain any income velocity of money, people are choosing to forgo the opportunity cost of accumulating interest on alternative assets by employing the money in the domestic economic system. Therefore, we can assume that the income velocity varies directly with the opportunity cost of money. What does all of this mean in terms of demand and supply for money?

This money sector curve illustrates the quantity of money that all firms and households want to hold under special conditions. The vertical axis represents nominal market interest rates. The quantity of money is the horizontal axis. The demand schedule of money is at a negative curve/slope which shows less quantities of money is demanded when interest rates are low; inversely, higher interest rates produce a higher demand of the quantities of money. The negative slope reflects the fact that, other things being equal, people want to hold less money and more non monetary assets as market interest rates rise. As market interest rates fall, people tend to reduce their holdings of non-monetary assets in order to gain the...