A study has estimated the effect of changes in interest rates and consumer confi

Question

A study has estimated the effect of changes in interest rates and consumer confidence on the demand for money to be: ln M = 14.666 + .021 ln C 0.036 ln r, where M denotes real money balances, C is an index of consumer confidence, and r is the interest rate paid on bank deposits. Based on this study, a 5 percent increase in interest rates will cause the demand for money to:

drop by 1.8 percent.

increase by 1.8 percent.

drop by 0.18 percent.

increase by 0.18 percent.

The answer is drop by .18 percent, why? please show me step by step

Explanation / Answer

ln M = 14.666 + .021 ln C 0.036 ln r

This is a linear regression relationship where the dependent variable is Money demand (M) and the independent variables are Consumer confidence (C) and Interest rate (r).

The coefficient of an independent variable signifies the magnitude and direction of change in M corresponding to a change in the independent variable.

Coefficient of 'r' is - 0.036. This means that, if 'r' increases by 1%, M will decrease by 0.036%.

So, when 'r' increases by 5%, M will decrease by 5 x 0.036% = 0.18%.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.