The Money Market (1 of 2)- Macro Topic 4.5

Summary

In this video, Mr. Clifford explains the money market graph, a key concept for AP Macroeconomics students. He covers the definition of M1 money, the difference between money and wealth, and the two main reasons people demand money: transaction demand and asset demand. The supply of money is controlled by the central bank and is independent of interest rates. Mr. Clifford discusses the role of monetary policy, including expansionary and contractionary policies, and how the Federal Reserve uses tools like the reserve requirement, discount rate, and open market operations to manage the money supply and influence the economy.

Takeaways

• 😀 Money is defined in the narrowest sense as M1, which includes cash, traveler’s checks, and checkable deposits in checking accounts.
• 😀 Money is different from wealth, as wealth includes assets like houses, cars, stocks, and bonds, which have low liquidity compared to money.
• 😀 M1 money has high liquidity, meaning it can quickly be converted into cash, while assets like real estate or stocks take time to sell for cash.
• 😀 The demand for money is driven by two factors: transaction demand (for buying goods/services) and asset demand (preference for liquid assets).
• 😀 The demand for money decreases when interest rates are high, as the opportunity cost of holding money increases.
• 😀 As interest rates fall, people are more willing to hold money, thus increasing the demand for it.
• 😀 Shifters of money demand include changes in the price level, income, and technological advancements (like credit cards reducing the need for physical cash).
• 😀 The supply of money is vertical on the money market graph because it is controlled and set by a country's central bank (e.g., the Federal Reserve in the U.S.).
• 😀 The graph doesn't reflect economic conditions like inflation or recession; instead, it focuses on monetary policy and its effect on interest rates.
• 😀 Expansionary monetary policy increases the money supply, lowering interest rates, which boosts investment and aggregate demand, while contractionary policy reduces the money supply to fight inflation.
• 😀 The three primary tools of monetary policy are the reserve requirement, the discount rate, and open market operations.

Q & A

What is the narrowest definition of money and what does it include?

The narrowest definition of money is called M1 money. It includes cash, traveler’s checks, and checkable deposits (money in checking accounts).

How does money differ from wealth?

Money refers to highly liquid assets, like cash and checking account balances, while wealth includes assets like houses, cars, and stocks, which are not considered money due to their low liquidity.

Why are assets like houses and cars not considered money?

Assets like houses and cars are not considered money because they have low liquidity, meaning they take time to convert into cash. Money, such as cash and checking account balances, is highly liquid.

What are the two reasons people demand money?

People demand money for two reasons: transaction demand (to buy goods and services) and asset demand (to have a liquid asset rather than other less liquid assets).

How does the interest rate affect the demand for money?

When the interest rate is high, the opportunity cost of holding money increases, reducing the demand for money. Conversely, when the interest rate falls, people are less concerned about holding money, so the demand for money increases.

What are some factors that can shift the demand for money curve?

Factors that can shift the demand for money curve include an increase in the price level (which raises the need for more money for transactions), an increase in income (which also raises the demand for money), and changes in technology (such as the widespread use of credit cards, which can reduce the demand for money).

What is the shape of the supply of money curve, and why?

The supply of money curve is vertical because the money supply is set and controlled by a country’s central bank, like the Federal Reserve in the U.S. It is not influenced by the interest rate.

How does the Federal Reserve use monetary policy to affect the economy?

The Federal Reserve uses monetary policy to influence the economy by increasing or decreasing the money supply. An increase in the money supply lowers interest rates, boosts investment, and increases aggregate demand. A decrease in the money supply raises interest rates, reduces investment, and decreases aggregate demand.

What is expansionary monetary policy and what is its effect?

Expansionary monetary policy occurs when the Federal Reserve increases the money supply. This lowers interest rates, increases investment, and raises aggregate demand to stimulate the economy.

What is contractionary monetary policy and what is its effect?

Contractionary monetary policy occurs when the Federal Reserve decreases the money supply. This raises interest rates, reduces investment, and decreases aggregate demand to help control inflation.

What are the three shifters of the money supply?

The three shifters of the money supply are the reserve requirement, the discount rate, and open market operations. These tools are used by the central bank to influence the money supply.