. © 1999-2003
Douglas A.Ruby

Aggregate Demand

Aggregate Expenditure

Money Demand

Principles of Macroeconomics

Macroeconomic Theory
Interest Rate Determination
The Liquidity Approach
Equilibrium in Financial Markets
The functional form for money demand (as derived from the Inventory Theoretic Model) is:
Md = f[Y , i ]
            (+)  (-)
In equilibrium Md = Ms or:
Md = M/P
where M/P represents the purchasing power of available money balances (the money supply). Holding the price level constant (no supply-side constraints), changes in purchasing power will only result via changes in the money supply. Additionally, if the price level is unchanging then nominal measures of income are the same as real income measures.

figure 1
An increase in the Money Supply		 figure 2
An increase in Income 'Y' and Md
An increase in the Money Supply (Real money balances) shifts the this function to the right. This is often a deliberate policy action (via open-market operations) usually intended to stimulate aggregate demand. The result is an Excess Supply of Money (specifically excess reserves and thus loanable reserves) such that interest rates fall. An increase in Income 'Y' leads to an outward shift in Money Demand (due the the need to support a greater level of transactions). This shift leads to an Excess Demand for Money where individuals will begin to make portfolio adjustments (selling bonds and securities thus Pbonds decline, Ybonds increase) pushing interest rates up.