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 = $140 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?

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 =

     Quantity of money demanded =

     Amount of money demanded for transactions =

     Amount of money demanded as an asset =

Explanation / Answer

With exogenous money supply the money supply would remain fixed at $180 billion.Transaction demand for money is equal to $140 billion.Speculative demand for money is = 10 billion at 12% rate of interest.

Equilibrium in money market requires equality between money supply and money demand.Given

money supply =180 billion

Transaction demand for money = 140 billion

for equilibrium speculative demand for money must be equal to $40 billion. This would happen only if interest rate falls to 6 percent.This is because with every fall in interest rates by 2 percent the speculative demand for money increases by 10 billion.Hence speculative demand or demand for money as an asset of 40 billion would be attained only if interest rates equal 6 percent.

At equilibrium

MONEY SUPPLY = 180 BILLION

MONEY DEMAND = TRANSACTIONS DEMAND + DEMAND FOR MONEY AS AN ASSET = 140 + 40 = 180 BILLION

TRANSACTION DEMAND = 140 BIILION

DEMAND FOR MONEY AS AN ASSET = 40 BILLION at 6 percent interest rate.

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