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The money market model

Understanding and creating graphs are critical skills in macroeconomics. In this article, you’ll get a quick review of the money market model, including:
  1. what it’s used to illustrate
  2. key elements of the model
  3. some examples of questions that can be answered using that model.

What it illustrates

The money market represents the how the nominal interest rate adjusts to make the amount of money that people want to hold equal to the money supply.

Key features of the money market

-Two axes: a vertical axis labeled “Nominal interest rate” or “n.i.r.” and a horizontal axis labeled “Quantity of Money” or Q, start subscript, M, end subscript.
  • A downward sloping money demand curve labeled D, start subscript, m, end subscript and a vertical money supply curve labeled S, start subscript, m, end subscript.
  • An equilibrium interest rate.

Helpful hints for the money market

  • The money market is a variation of the market graph.
  • Be cautious with labels use only standard abbreviations if you decide to use abbreviate: “n.i.r.” for nominal interest rate, “S, start subscript, M, end subscript” for the money supply curve, “D_m” for the money demand curve, and “Q, start subscript, M, end subscript” for the quantity of money.
  • Always label equilibrium interest on the vertical axis, NOT in the interior.
  • Use arrows to indicate the direction of a change and numbers to indicate the order of the change. For example, the graph below indicates that the money supply increased from S, start subscript, M, 1, end subscript to S, start subscript, M, 2, end subscript, which caused the nominal interest rate to decrease from i, start subscript, 1, end subscript to i, start subscript, 2, end subscript:

Try it yourself

Here is a question from the 2017 AP Macroeconomics Exam that uses the money market. Try to solve it on your own, and then click on the solution to compare your work to the correct answer.

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