AP_Krugman_Textbook

45 cents and a gallon of gasoline for 29 cents. So higher prices increase the de-

mand for money (a rightward shift of the MDcurve), and lower prices reduce the

demand for money (a leftward shift of the MDcurve).

We can actually be more specific than this: other things equal, the demand for

money is proportionalto the price level. That is, if the aggregate price level rises by

20%, the quantity of money demanded at any given interest rate, such as r 1 in

Figure 28.2, also rises by 20%—the movement from M 1 toM 2. Why? Because if

the price of everything rises by 20%, it takes 20% more money to buy the same

basket of goods and services. And if the aggregate price level falls by 20%, at any

given interest rate the quantity of money demanded falls by 20%—shown by the

movement from M 1 toM 3 at the interest rate r 1. As we’ll see later, the fact that

money demand is proportional to the price level has important implications for

the long -run effects of monetary policy.

Changes in Real GDPHouseholds and firms hold money as a way to facilitate

purchases of goods and services. The larger the quantity of goods and services

they buy, the larger the quantity of money they will want to hold at any given in-

terest rate. So an increase in real GDP—the total quantity of goods and services

produced and sold in the economy—shifts the money demand curve rightward.

A fall in real GDP shifts the money demand curve leftward.

Changes in Technology There was a time, not so long ago, when withdraw-

ing cash from a bank account required a visit during the bank’s hours of

operation. And since most people tried to do their banking during lunch

hour, they often found themselves standing in line. So people limited the number of

times they needed to withdraw funds by keeping substantial amounts of cash on

hand. Not surprisingly, this tendency diminished greatly with the advent of ATMs

in the 1970s. As a result, the demand for money fell and the money demand curve

shifted leftward.

These events illustrate how changes in technology can affect the demand for

money. In general, advances in information technology have tended to reduce the

demand for money by making it easier for the public to make purchases without

272 section 5 The Financial Sector

figure 28.2

Increases and Decreases in

the Demand for Money

A rise in money demand shifts the money de-

mand curve to the right, from MD 1 toMD 2 , and

the quantity of money demanded rises at any

given interest rate. A fall in money demand

shifts the money demand curve to the left, from

MD 1 toMD 3 , and the quantity of money de-

manded falls at any given interest rate.

Quantity

of money

A rise in money demand

shifts the money demand

curve to the right.

MD MD^1 MD^2

3

Interest

rate, r

M 3 M 1

r 1

M 2

A fall in money demand

shifts the money demand

curve to the left.

A re-creation of a McDonald’s in the

1950s at the Ford Museum in Detroit,

Michigan

© tom carter/Alamy© tom carter/Alamy