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Q. Explain money market and price changes?
The money market and price changes
The money demand curve will shift to the right (left) in themoney market diagram if P increases (decreases).
Money supply is an exogenous variable controlled by central bank so there is no automatic mechanism that will change MS when P changes. Remember that money market figure demonstrates the supply and demand for money as functions of R everything else held fixed. Hence we can still use the money market figure in AS-AD model as long as we keep P fixed.
We should now determine how to analyze changes in P in the money market. To do this, keep P constant at two different levels P1 = 10 and P2 = 20. We know that MDrely positively on P and MD(Y, R, P2) > MD(Y, R, P1). Demand for money increases when P increases if Y and R don't change.
Figure: Money market diagram with different prices
If P increases, demand for money will increase for all interest rates. This means that demand curve should be shifted outwards to right when P increases. Note that with a fixed Y and a fixed money supply, if P increases, R should increase for the money market to remain in equilibrium.
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