Final answer:
The portfolio balance model explains how changes in the money supply affect asset prices and interest rates, and individuals hold their wealth in different assets, including money, bonds, and stocks.
Step-by-step explanation:
The portfolio balance model is an economic theory that explains how changes in the money supply affect asset prices and interest rates. According to the model, individuals hold their wealth in the form of different assets, including money, bonds, and stocks. When the money supply increases, individuals will have excess money that they will seek to invest in other assets. This increased demand for bonds and stocks drives up their prices and lowers interest rates.
For example, let's say the central bank decides to increase the money supply by buying government bonds from the public. This action injects money into the economy, increasing individuals' holdings of money. As a result, individuals may decide to use this excess money to buy bonds or stocks, leading to an increase in their prices.
Overall, the portfolio balance model demonstrates that changes in the money supply can have significant effects on asset prices and interest rates in an economy.