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Q. Explain the Money market diagram?
Let's begin by studying the money market when GDP is given. When Y is given, MD will only rely (negatively) on R and we can draw a figure with supply and demand for money as functions of R.
Figure
In the figure above, R* is the interest rate in that demand for money is exactly equal to the supply of money (again for a given Y). IS-LM model, R will all the time tend to R* till they are equal and we have an equilibrium in money market.
Justification for why R will tend to R* is not completely straightforward:
Money market diagram can be used to conclude the equilibrium rate of interest if we know GDP
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