CA Foundation · Business Economics · Money Market
In the standard money market diagram, with the interest rate on the vertical axis and the quantity of money on the horizontal axis, the money supply curve is drawn as a vertical line. What does this represent?
A vertical money supply curve means the quantity of money is fixed by the central bank and does not respond to the interest rate. Equilibrium is then found by where the downward-sloping money demand curve cuts this fixed supply.
- AMoney supply is fixed by the central bank and does not change with the interest rateCorrect
- BMoney supply rises steadily as the interest rate rises
- CMoney supply falls as the interest rate rises
- DMoney supply is determined by the public's demand for money at each rate
Explanation
In the basic model the central bank sets the money supply, so it is independent of the interest rate and the curve is vertical. Options 2 and 3 treat supply as interest-sensitive, which is not the assumption of the basic model. Option 4 confuses supply with demand.
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