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IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy

An Indian bank notes that, other things equal, a rise in nominal national income shifts the money demand curve. Which description is correct, using a diagram with the interest rate on the vertical axis and the quantity of money on the horizontal axis?

The money demand curve shifts to the right. Higher nominal income increases spending and so transactions and precautionary demand for money at every interest rate. This is a shift of the curve, not a movement along it, which would only follow an interest rate change.

  1. AThe demand curve shifts to the right, so at any given interest rate more money is demandedCorrect
  2. BThe demand curve shifts to the left, because households save more
  3. CThere is a movement down along the existing curve
  4. DThe curve becomes vertical at all interest rates
  5. The curve shifts right only if the money supply also rises

Explanation

Higher income raises transactions and precautionary demand at every interest rate, which shifts the whole money demand curve to the right. A change in the interest rate, by contrast, would cause a movement along the curve. The money supply does not determine the shift in demand.

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