If the demand for money depends positively on real income and depends inversely on the nominal interest rate, what will happen to the price level today, if the central bank announces (and people believe) that it will decrease the money growth rate in the future, but it does not change the money supply today?
The same relationship is quite likely to hold even for much smaller changes in interest rates. This implies that as interest rates rise (fall), the demand for money will fall (rise). The speculative demand for money, then, simply relates to component of the money demand related to interest rate effects.

Does Money Demand Depend On Real Or Nominal Interest Rate Definition
Does Money Demand Depend On Real Or Nominal Interest Rate Graph

May 21, 2020 Generally, the nominal demand for money increases with the level of nominal output (price level times real output) and decreases with the nominal interest rate. The real demand for money is defined as the nominal amount of money demanded divided by the price level. Jan 15, 2019 Changes in the demand for money can also affect the nominal interest rate in an economy. As shown in the left-hand panel of this diagram, an increase in the demand for money initially creates a shortage of money and ultimately increases the nominal interest rate.

Nouriel Roubini

Understanding theWorld Macroeconomy

Handout for Chapter 5:

Output and Real Interest Rates

The Production Function Again

Y = A F(K, N) (1)

In the short run K is approximately constant:

Y = A F(K, N) (2)

Features of (2):

1. Output (Y) is increasing in employment (N). (Figure1)

2. Diminishing returns to labor: (Figure2)

MPN = dY/dN = A dF(K, N)/dN

MPN = Marginal Product of Labor

Shifts of the production function:

1. Increases in A (due to technological development) shiftthe production function upward.

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2. Decreases in A (due to negative shocks such as oilprice shocks) shift the production function downward.

3. Increases in the capital stock (K) shift the productionfunction upward.

Shifts of the curve versus shifts alongthe curve.

The Labor Market

Labor Demand

An extra unit of labor produces MPN extra units of output Iphone apps that can earn you money.

The value of this additional output is P x MPN

The cost of an additional unit of labor is W (the wagerate)

A profit maximizing firm will employ labor N up to thepoint where:

P x MPN = W or MPN = W/P (W/P = real wage)

P x MPN = Value of the marginal product of labor

Example:

N	MPN	P	PxMPN	W
1	11	2	22	14
2	10	2	20	14
3	9	2	18	14
4	8	2	16	14
5	7	2	14	14
6	6	2	12	14
7	5	2	10	14

So the otpimal amount of employment is 5 workers because:

2 x 7 = P x MPN = W = 14

Note that the MPN curve is the (inverse) demand for labor.

Labor demand depends also on:

1. Productivity A. If A increases, MPN increases at everylevel of N. So, labor demand increases.

2. The stock of capital (K). Higher K increases MPN atevery level of N. So, labor demand increases.

3. An oil shock reduces A and reduces the demand for labor.

4. Taxes and fringe benefits. With a payroll tax (at therate f), the cost to a firm of an additional unit of labor is W (1+f).So:

P MPN = W (1+f) or MPN/(1+f) = W/P

So a payroll tax increases real labor costs and reduceslabor demand.

Labor Supply

Labor supply increases when the real wage (W/P) goes up:

NS = F(W/P)

Caveat on substitution and income effects.

Other variables affecting the labor supply:

1. Demographic factors (immigration, population growth,labor force participation rates).

2. Income taxes NS = F ( (1-t)W/P )

t = income tax rate

Equilibrium in labor market:

ND = NS (labor demand = labor supply) (Figure3)

The equilibrium is affected by:

1. Income tax rates (t). Higher t leads to lower N, higherW/P and lower after tax real wages (1-t)W/P.

2. Payroll tax rates (f). Lower f leads to higher N, higherW/P and lower after tax cost of labor for firms (1+f)W/P.

3. Changes in the stock of capital (K). Higher K leadsto higher employment N and higher real wages (W/P).

4. Changes in the level of productivity A. Lower A leadsto lower N, lower W/P and lower output.

Output, factor payments and income distribution

From the national income accounts:

Output = Value Added = Income (Payments to the factorsof production)

Nominal value of output = P x Y = W N + R K = Wages +Total Profits

or: Y = (W/P) N + (R/P) K = w N+ r K

where:

w = real wage (W/P)

r = real rental (return) to capital (R/P)

Dividing by Y, we get:

1 = (WN)/(PY) + (RK)/(PY) = s^l+

Does Money Demand Depend On Real Or Nominbal Interest Rate