Which statement describes the money demand curve?

Which statement describes the money demand curve?

• A. The money demand curve illustrates the quantity of money demanded at a given interest rate and is downward sloping.
• B. The money supply curve shows the actual supply of money circulating in an economy.
• C. Both curves slope upward as interest rates rise.
• D. The money supply curve represents the public's preference for liquidity at different interest rates.

Answer: (B)

The key idea here is how the money market shows the relationship between the interest rate and how much money people want to hold. The money demand curve slopes downward because when interest rates rise, holding money becomes more costly in terms of foregone interest, so people prefer to hold less money and put more into interest-earning assets. In other words, higher rates reduce the quantity of money people demand. Money supply, on the other hand, is about how much money is available in the economy. That is typically regarded as set by the central bank and is shown as a vertical (exogenous) line in the standard model, meaning it doesn’t depend on the current interest rate in the short run. So a statement describing the money supply as the actual supply of money circulating is describing the supply side, not the money demand curve. The option that correctly matches the money demand curve is the one that says it shows the quantity of money demanded at each interest rate and that it is downward sloping. The other statements mix up demand and supply or misattribute the concept to liquidity preferences, which correspond more to money demand rather than the supply curve.

The key idea here is how the money market shows the relationship between the interest rate and how much money people want to hold. The money demand curve slopes downward because when interest rates rise, holding money becomes more costly in terms of foregone interest, so people prefer to hold less money and put more into interest-earning assets. In other words, higher rates reduce the quantity of money people demand.

Money supply, on the other hand, is about how much money is available in the economy. That is typically regarded as set by the central bank and is shown as a vertical (exogenous) line in the standard model, meaning it doesn’t depend on the current interest rate in the short run. So a statement describing the money supply as the actual supply of money circulating is describing the supply side, not the money demand curve.

The option that correctly matches the money demand curve is the one that says it shows the quantity of money demanded at each interest rate and that it is downward sloping. The other statements mix up demand and supply or misattribute the concept to liquidity preferences, which correspond more to money demand rather than the supply curve.