Question

The rate of interest is a price:

a. Of what is it the price?
b. What determines this price? (Sketch a relevant graph of the money market).
c. What factors influence the demand for money?
d. What factors influence the supply of money?
e. If the money market is in short-run equilibrium, explain the adjustments that will take place for:
i) an increase the in money supply
ii) increase in the demand for money

Answer 1

a. It is the price of money.

b. Money demand and supply determine this price.

c. Factors that influence the demand for money are:

Interest Rates, Consumer Spending, Precautionary Motives, Transaction Costs for Stocks and Bonds, Change in the General Level of Prices, International Factors.

d. Factors that influence the supply of money are:

Open market operations, reserve requirement and the policy interest rate set by the central bank.

e. If the money market is in short-run equilibrium:

i) an increase in the money supply will cause an increase in quantity of money and a decrease in interest rate.

ii) increase in the demand for money will cause an increase in quantity of money and an increase in interest rate.