MacroeconomicsI_working_version (1)

Money Market, Money Supply, Money Demand 71
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Figure 7.8 Changing equilibrium in the money market. A rise in nominal GDP induces a rising interest
rate until the equilibrium is restored. A rise in the money stock reflecting an expansionary monetary policy
shifts the curve of money supply to the right. An equilibrium interest rate must decline to clear the money
market.
In examining the changes in equilibrium in the money market a question can emerge - how does the money
market clear? A decline in the money supply creates temporary shortage of money; because with money
demand unchanged the public (households and firms) demand more money than they hold (money supply).
To gain more money people sell bonds. The excess supply of bonds lowers the bond prices, which push up
the interest yields. With higher interest rates people reduces their demand for money – the amount of money
they want to hold – until the supply of money matches the demand for money. The equilibrium interest rate
clears the money market.
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Figure 7.9 Process of restoring equilibrium in the money market.