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Marlow Works

AP Macroeconomics / Financial Sector

Lesson

Money, banks, and the money market

Money is a tool for trade. Banks multiply deposits. The money market sets a nominal rate.

Learning goals

  • Name the functions of money.
  • Explain how a bond purchase by the central bank increases bank reserves.

Explanation

Money is a medium of exchange, a unit of account, and a store of value. Currency and checkable deposits are the everyday core. Banks hold reserves and lend the rest. A new loan becomes a new deposit somewhere in the system, which is why the money supply can exceed the cash in vaults.

Money demand rises when people want more liquidity, often because income is higher or nominal rates are lower. Money supply is set, in the basic model, by the central bank. An open-market purchase of bonds injects reserves, shifts money supply right, and lowers the nominal interest rate if demand is unchanged.

Key terms

  • Medium of exchange. The use of money to buy goods and services without barter.
  • Open-market operation. A central-bank purchase or sale of securities used to change bank reserves and the money supply.

Common mistakes

  • Drawing loanable funds when the question is about the money market.
  • Saying banks lend out all deposits, ignoring reserve requirements or chosen reserves.

Practice

Original Marlow Works items. Check the answer explanation after you try.

1 of 2Economic Indicators and the Business Cycle · easy · multiple choice

Nominal GDP rises from one year to the next while real GDP is unchanged. Which interpretation is best?

Original Marlow Works item — not a College Board question.

Take your time—this is practice, not a test.

Answer explanation

People suddenly want to hold more cash at every interest rate. What happens in the money market?

Answer. Money demand shifts right and the nominal interest rate rises if money supply is unchanged.

A rush to liquidity bids up the price of money, which in this model is the interest rate.

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Related resources

External links with reuse status. Marlow Works is independent and does not copy restricted exam or textbook material.

  • Official / link only

    AP Macroeconomics course page

    Official six-unit framework for national income and policy models.

    College Board · All rights reserved · accessed 2026-10-01

    Open source

  • Official / link only

    FRED economic data

    Federal Reserve economic data. Terms vary by series; do not scrape or ingest.

    Federal Reserve Bank of St. Louis · Varies by series · accessed 2026-10-01

    Open source