Page 314 - Krugmans Economics for AP Text Book_Neat

figure 28.2

Increases and Decreases in Interest
rate, r
the Demand for Money A fall in money demand
shifts the money demand
A rise in money demand shifts the money de- curve to the left.
mand curve to the right, from MD 1 to MD 2 , and
the quantity of money demanded rises at any
given interest rate. A fall in money demand
shifts the money demand curve to the left, from
MD 1 to MD 3 , and the quantity of money de- A rise in money demand
manded falls at any given interest rate. shifts the money demand
curve to the right.
r 1

MD 1 MD 2
MD 3

M 3 M 1 M 2 Quantity
of money

45 cents and a gallon of gasoline for 29 cents. So higher prices increase the de-
mand for money (a rightward shift of the MD curve), and lower prices reduce the
demand for money (a leftward shift of the MD curve).
We can actually be more specific than this: other things equal, the demand for
money is proportional to the price level. That is, if the aggregate price level rises by
20%, the quantity of money demanded at any given interest rate, such as r 1 in
Figure 28.2, also rises by 20%—the movement from M 1 to M 2 . Why? Because if
the price of everything rises by 20%, it takes 20% more money to buy the same
basket of goods and services. And if the aggregate price level falls by 20%, at any
given interest rate the quantity of money demanded falls by 20%—shown by the
movement from M 1 to M 3 at the interest rate r 1 . As we’ll see later, the fact that
money demand is proportional to the price level has important implications for
the long -run effects of monetary policy.
Changes in Real GDP Households and firms hold money as a way to facilitate
© tom carter/Alamy© tom carter/Alamy they buy, the larger the quantity of money they will want to hold at any given in-
purchases of goods and services. The larger the quantity of goods and services
terest rate. So an increase in real GDP—the total quantity of goods and services
produced and sold in the economy—shifts the money demand curve rightward.
A fall in real GDP shifts the money demand curve leftward.
Changes in Technology There was a time, not so long ago, when withdraw-
ing cash from a bank account required a visit during the bank’s hours of
A re-creation of a McDonald’s in the operation. And since most people tried to do their banking during lunch
1950s at the Ford Museum in Detroit,
Michigan hour, they often found themselves standing in line. So people limited the number of
times they needed to withdraw funds by keeping substantial amounts of cash on
hand. Not surprisingly, this tendency diminished greatly with the advent of ATMs
in the 1970s. As a result, the demand for money fell and the money demand curve
shifted leftward.
These events illustrate how changes in technology can affect the demand for
money. In general, advances in information technology have tended to reduce the
demand for money by making it easier for the public to make purchases without

272 section 5 The Financial Sector