If the quantity of money demanded is $600 billion, and the quantity of money supplied is $400 billion, then the interest rate will

• A. Remain unchanged
• B. Be in equilibrium
• C. Rise
• D. Fall

Answer: (C)

In the money market, the interest rate is the price that clears money demand and money supply. Here, people want to hold 600 billion of money, but only 400 billion is available. That excess demand of 200 billion puts upward pressure on the interest rate. As the rate rises, holding money becomes less attractive, so the quantity of money demanded falls toward the fixed supply, and the market moves toward balance. Since there is a shortage at the original rate, the rate must rise to restore equilibrium. That’s why the correct outcome is that the interest rate will rise.