Explain the concept of equilibrium in money markets.

Explain the concept of equilibrium in money markets. 

Ans. The demand for money has two components: transactional demand and asset demand. 

Transactional demand (Dt) is money kept for purchases and will vary directly with GDP. 

Asset demand (Da) is money kept as a store of value for later use. Asset demand varies inversely with the interest rate, since that is the price of holding idle money.

Total demand for money will equal quantities of money demanded for assets plus that for transactions.

The demand curve for money illustrates the inverse relationship between the quantity demanded of money and the interest rate. 

The supply of money is a vertical line, suggesting the quantity of money is fixed at a level largely determined by the Fed. Equilibrium in the money market exists when the quantity demanded of money equals the quantity supplied.