THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 136

104

PA R T I I

Financial Markets

Interest Rate, i

Ms

2

i2

1

i1

M d1

M d2

M
Quantity of Money, M

F I G U R E 5 - 10

Response to a Change in Income or the Price Level

In a business cycle expansion, when income is rising, or when the price level rises, the demand
curve shifts from M d1 to M d2 . The supply curve is fixed at M s * M. The equilibrium interest rate

rises from i1 to i2.

Interest Rate, i

M 1s

i1

1

i2

M s2

2

Md

Quantity of Money, M

F I G U R E 5 - 11

Response to a Change in the Money Supply

When the money supply increases, the supply curve shifts from M 1s to M 2s, and the equilibrium
interest rate falls from i1 to i2.