In the money market, when money demanded equals money supplied, the interest rate is

• A. Rise
• B. Remain unchanged
• C. Fall
• D. In equilibrium

Answer: (D)

The main idea is that the money market clears when money demanded equals money supplied. At that point the interest rate is at its equilibrium level, determined by the fixed money supply and the downward-sloping money demand curve. When the rate is high, people want to hold less money and more in interest-earning assets; when the rate is low, holding money becomes more attractive. The central bank sets the money supply, and the intersection with money demand fixes the rate. If there were excess demand, the rate would rise; if there were excess supply, the rate would fall. So when they are equal, the rate is in equilibrium.