2. Money supply, money demand, and adjustment to monetary equilibrium The following table gives the quantity of money demanded at various price levels (P), the money demand schedule. In the following table, fill in the column labeled Value of Money. Quantity of Money Demanded Price Level (P) Value of Money (1/ P) (Billions of dollars) 1.00 _V 1.5 1.33 _'V 2.0 2.00 _V 3.5 4.00 _'v 7.0 Now consider the relationship between the quantity of money that people demand and the price level. The lower the price level, the '7 money required to complete transactions, and the '7 money people will want to hold in the form of currency or demand deposits. Assume that the Federal Reserve initially fixes the quantity of money supplied at $3.5 billion. Use the orange line (square symbol) to plot the initial money supply (M31) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve. 1.25 El 1.00 M31 0 E z 015 Money Demand 0 E u. _o_ O s a. 0.50 M32 > 0.25 VALUE OF MONEY 1 ,25 1,00 0.75 0.50 0.25 | i { I I i | 1 2 3 4 5 6 QUANTITY OF MONEY (Billions of dollars) 7 + M31 -0- Money Demand _0_ MS According to your graph, the equilibrium value of money is V , therefore the equilibrium price level is V . Now, suppose that the Fed increases the money supply from the initial level of $3.5 billion to $7 billion. In order to increase the money supply, the Fed can use open market operations to V the public. Use the purple line (diamond symbol) to plot the new money supply (M32). Immediately after the Fed changes the money supply from its initial equilibrium level, the quantity of money supplied is 7 than the quantity of money demanded at the initial equilibrium. This expansion in the money supply will '7 people's demand for goods and services. In the long run, since the economy's ability to produce goods and services has not changed, the prices of goods and services will 'l" and the value of money will 7