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 = $190 billion; quantity of money demanded for transactions = $150 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. Instructions: Enter your answers as whole numbers. a. What is the equilibrium interest rate in Trance? percent.
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?
Quantity of money supplied = $ billion.
Quantity of money demanded = $ billion.
of money demanded for transactions = $ billion.
Amount of money demanded as an asset = $ billion.

Explanation / Answer

a) At equilibrium Money demand equals money supply.

Money supply = 200 dollar billion

and Money demand = money demand for transaction + money demand for asset

We have money demand for transacction = 150 billion dollar

Hence at equilibrium

Money demand for asset = 200 - 150 = 50 dollar billion

It implies we need to find at what ineterest rate money demand for asset will be $50 billion.

It is given that at 12% money demand for asset is 10 billion dollar and it increases by $10 billlion when interets rate fall by 2%.

Thus at 12% the money demand for asset = 10 billion

at 10 % it is 10 + 10 = 20

at 8% it is 20 + 10 = 30

at 6% it is 30 + 10 = 40

and at 4% it is 40+ 10 = $50 billion

Thus at 4% the money demand for asset is $50 billion which is rqeuired to have equilibrium.

Therefore the equilibrium interest rate is 4%.

b) At equilibrium interest rate the money supplied equals money demanded.

Hence the money supplied will be $200 billion.

and total money demanded will be $200 billion.

As total money demanded is sum of money demand of transaction and money demand of asset.

We already find that at 4% money demand for asset is $50 billion

and money demand for transaction is $150 billion.

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