When the demand for money is greater than the supply of money:  A)people offering to sell nonmonetary financial assets must increase the interest rate these assets pay in order to sell them. B)more people will hold money. C)the opportunity cost of holding money will fall. D)interest rates will fall.

Question
Asked Apr 11, 2019
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When the demand for money is greater than the supply of money:

 

 

A)

people offering to sell nonmonetary financial assets must increase the interest rate these assets pay in order to sell them.

 

B)

more people will hold money.

 

C)

the opportunity cost of holding money will fall.

 

D)

interest rates will fall.

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Expert Answer

Step 1

Money demand is the demand for cash balances by the individuals in the economy.

Money supply is the total stock of money in the economy at a point of time.

Step 2

Demand for money curve shows the combinations of interest rate and corresponding money demand. Interest forgone is the cost of holding money. Therefore, at a higher interest rate, the demand for money would be lower. Therefore, the demand for money curve slopes downwards.

Money supply is fixed at a point of time. Hence, the money supply curve is independent of interest rate and money supply is represented by a vertical line parallel to interest rate axis.

The intersection of demand for and supply of money determine the equilibrium interest rate and quantity of money as shown below.

Md: Money demand

Ms: Money supply

M*: Equilibrium quantity of money

i* : Equilibrium interest rate

 

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Step 3

When the demand for money is greater than the supply of money, it implies that at the prevailing interest rate, people prefer to hold money over financial assets. Therefore, those selling financial assets need to make the returns (interest) on assets more attractive to make people purchase those financial assets. It is becau...

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