The Money Market

Holding cash costs you something even if it never moves, because you give up the interest you could have earned by putting that money into bonds or savings instead. That forgone interest is the opportunity cost of holding money, and it is why money demand slopes downward: at a high nominal interest rate, holding cash is expensive, so people hold less of it and put more into interest-earning assets; at a low rate, holding cash is cheap, so people hold more of it.

Money supply, by contrast, is drawn as a vertical line. The quantity of money in circulation is set by the central bank through policy tools like open market operations, not by how attractive the interest rate is. A bank or the public does not decide to supply more money just because the interest rate rises, the way a firm supplies more wheat at a higher price. So the vertical line is not really a supply curve in the ordinary sense, it is a fixed quantity. The nominal interest rate is whatever rate makes the quantity of money people want to hold equal to that fixed quantity. If the current rate is below equilibrium, there is a shortage of money, people sell bonds to raise cash, bond prices fall, and interest rates rise back to equilibrium. If there's a surplus of money at the current rate, people use the excess cash to buy bonds, bond prices rise, and the interest rate falls until the surplus disappears.

This nominal rate connects to the real rate from loanable funds through the Fisher equation: nominal rate equals real rate plus expected inflation. The real rate reflects the price of borrowing after accounting for inflation; the nominal rate is what actually shows up on a loan contract.