Q. Explain money market and price changes?

The money market and price changes

Money supply is an exogenous variable controlled by central bank so there is no automatic mechanism that will change M_S when P changes. Remember that money market figure demonstrates the supply and demand for money as functions of R everything else held fixed. Hence we can still use the money market figure in AS-AD model as long as we keep P fixed. 

We should now determine how to analyze changes in P in the money market. To do this, keep P constant at two different levels P₁ = 10 and P₂ = 20. We know that M_Drely positively on P and M_D(Y, R, P2) > M_D(Y, R, P1). Demand for money increases when P increases if Y and R don't change.

Figure: Money market diagram with different prices

If P increases, demand for money will increase for all interest rates. This means that demand curve should be shifted outwards to right when P increases. Note that with a fixed Y and a fixed money supply, if P increases, R should increase for the money market to remain in equilibrium.