Answer to Question #128465 in Macroeconomics for Denis

Question

Money demand and money supply is given by (M/P)d = 1000r and (M/P)S=1000 and the price level is 2
a) Graph the supply and demand for real money balances
b) What is equilibrium interest rate?
c) Assume the price level is fixed
d) what happens to equilibrium interest rate if the supply of money is raised from 100 to 1200
e) If the central bank was to raise the interest rate to 7% what money supply should it set?

Answer 1

a) The supply and demand for real money balances are depicted with to curves (M/P)d and (M/P)s, which intersect in equilibrium point.

b) The equilibrium interest rate is:

1000r = 1000,

r = 1%.

c) If the price level is fixed, then the interest rate is fixed too.

d) If the supply of money is raised from 1000 to 1200, then the equilibrium interest rate will increase to $1200/1000 = 1.2$

e) If the central bank was to raise the interest rate to 7% the money supply that should be set is: $1000×7 = 7000.$