Question

Question 3 of 4 > Stacked Aggregate Demand I - Work It Out: Question 2 Suppose that the money demand function is = 600 - 75 wherer is the interest rate in percent. The money supply M is $1200, and the price level P is fixed at 4. Round answers to one place after the decimal when necessary. a. Graph the supply and demand of real money balances by moving points A and B to graph the demand for money and moving points and D to graph the supply of money y. D 10 . 9 o A ONI O + $ 96 A & 4 5 6 7 0 8 9 у O u P h k JE 00 .

Answer 1

The money demand is given as

(M/P)d = 600 - 75.r..........(1)

The Money Supply is given as

Ms = $1200

The price level is fixed at

P = $4

Hence, real money supply is

(M/P)s = (1200/4)

or, (M/P)s = 300........(2)

(a)The following diagram contains the money demand and money supply curves.

r (M/P)s = 300 C 8 A 6 4 E 2 (M/P)d = 600-75.r (M/P) D B 0 100 200 300 400 500 600 700

(b) The equilibrum in the market is at point E in the above diagram where (M/P)s and (M/P)d intersects.

The equilibrium interst rate corresponding to point E is 4%.

The equilibrum interest rate, r is 4%.

(c) If the money supply increased from $1200 to $1650.

Hence, real money supply is

(M/P)s = (1650/4)

or, (M/P)s = 412.5

Hence, at equilibrum,

(M/P)d = (M/P)s

or, 600 - 75.r = 412.5

or, 75.r = 187.5

or, r = 2.5

The equilibrum rate of interest falls to 2.5%.

(d) If the central bank wants the interest rate to be 6.5%, then the money demand for r = 6.5 is

(M/P)d = 600 - 75.r = 600 - 75×6.5

or, (M/P)d = 112.5

Price is fixed at P = $4

Hence, at equilibrum

(M/P)s = (M/P)d

or, (M/P)s = 112.5

or, Ms/4 = 112.5

or, Ms = $450

​​​​​​It should set money supply Ms = $450.

Hope the solutions are clear to you my friend.