Assume that the following data characterize the hypothetical economy of Trance:

Question

Assume that the following data characterize the hypothetical economy of Trance: money supply = $180 billion; quantity of money demanded for transactions = $160 billion; quantity of money demanded as an asset = $10 billion at 12 percent interest, increasing by $10 billion for each 2-percentage-point fall in the interest rate. a. What is the equilibrium interest rate in Trance? % b. At the equilibrium interest rate, what are the quantity of money supplied, the total quantity of money demanded, the amount of money demanded for transactions, and the amount of money demanded as an asset in Trance? Instructions: Enter only whole numbers for your answers below. Quantity of money supplied = $ billion Quantity of money demanded = $ billion Amount of money demanded for transactions = $ billion Amount of money demanded as an asset = $ billion

Explanation / Answer

in any supply and demand diagram, the supply line and demand line always intersect. there are also 2 parameters: quantity and rate/price.

in a LM diagram, the money supply line is vertical, so the money supply is fixed at $180bn. i.e. quantity of money is $180b. Now you need to find out how the demand curve intersects the money supply curve and at what rate.
there is currently $160bn in circulation, so from the quantity of money supplied, there is $20bn that would vary depending on rates charged, before it intersects the supply curve.
at 12%, the amount demanded is $10bn, and the quantity increases by $10bn for every 2 percent points decreased. it would take another $40bn before the demand curve hits the supply curve; that should be another 8% points deducted from 12% before the money demand curve crosses over the money supply curve (4*2%= 8%). This means the equilibrium rate should be 4%.

a) 4%
b) Money supplied = $180bn
money demanded = $180bn (demand = supply)
amount of money demanded for transactions = $160bn
amount demanded as an asset = $20bn ($180bn - $160bn)

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