Filip Vachuda

Section 10

Discussion 35 (Federico)

1. In the money market model, money demand depends negatively on the value of money, holding

income constant.

a. Suppose income decreases overall, how would this impact money demand? Please specify whether

money demand increases or decreases, and explain briefly (1 sentence would be enough!).

If income decreases, the demand for money would decrease. This is because people would save more to

compensate for their falling incomes and would thus choose to hold fewer assets in the form of money,

which does not generate any income in its form, but rather exists to spend.

b. The price level increases as people are making less money relative to before, and it is reflected with

the new decrease in demand. Quantity stays the same, but price level rises to point B.

C. As the lack of demand has resulted in a higher price level, the central bank/Fed can decrease the

money supply, for instance, through open-market operations. As that happens, point C is created at the

same price level as initial point A. This happens because incomes falling proportional to money supply

falling means there is no loss in real income, and thus no change in price level.