Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 12 Short Run Macroeconomic Fluctuations
Chapter 34 of 36 The Influence of Monetary and Fiscal Policy on Aggregate Demand
Section 6 of 35
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Figure 1 here
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Here we look at the two pieces of the theory of liquidity preference:
1· the supply of money
2· the demand for money
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2· The demand for money
The liquidity of any asset means the ease with which that asset can be used to buy goods (and services).
Money is the most liquid asset since it can directly be used for buying goods.
The high liquidity of money explains the demand for it.
People choose to hold some money instead of assets that offer a return (interest, dividends, asset value appreciation) because money immediately can be used to buy goods.
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There are other factors that determine the quantity of money demanded, but the one emphasized by the theory of liquidity preference is the interest rate.
The interest rate is the opportunity cost of holding money instead holding it in an asset that offers an interest return, such as a bond.
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An increase in the interest rate raises the opportunity cost of holding money, decreasing the quantity of money demanded.
A decrease in the interest rate reduces the opportunity cost of holding money,
increasing the quantity of money demanded.
So, per Figure 1 the money demand curve slopes downward.
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the interest rate is the opportunity cost of holding money
kinri wa kahei hoyū no kikai hiyō de arimasu
金利 は 貨幣 保有 の 機会 費用 で あります
May be an image of blueprint and text that says '1 FIGURE Interest Rate Equilibrium in the Money Market Money supply Equilibrium interest rate 「2 Mi Money demand Quantity fixed by the Fed Mg Quantity of Money'
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