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The money market model

Understanding and creating graphs are critical skills in macroeconomics. In this article, you’ll get a quick review of the money market model, including:
  1. what it’s used to illustrate
  2. key elements of the model
  3. some examples of questions that can be answered using that model.

What it illustrates

The money market represents the how the nominal interest rate adjusts to make the amount of money that people want to hold equal to the money supply.

Key features of the money market

-Two axes: a vertical axis labeled “Nominal interest rate” or “n.i.r.” and a horizontal axis labeled “Quantity of Money” or QM.
  • A downward sloping money demand curve labeled Dm and a vertical money supply curve labeled Sm.
  • An equilibrium interest rate.

Helpful hints for the money market

  • The money market is a variation of the market graph.
  • Be cautious with labels use only standard abbreviations if you decide to use abbreviate: “n.i.r.” for nominal interest rate, “SM” for the money supply curve, “D_m” for the money demand curve, and “QM” for the quantity of money.
  • Always label equilibrium interest on the vertical axis, NOT in the interior.
  • Use arrows to indicate the direction of a change and numbers to indicate the order of the change. For example, the graph below indicates that the money supply increased from SM1 to SM2, which caused the nominal interest rate to decrease from i1 to i2:

Try it yourself

Here is a question from the 2017 AP Macroeconomics Exam that uses the money market. Try to solve it on your own, and then click on the solution to compare your work to the correct answer.

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