Suppose that the money demand is given by: Md = PY(0.25 ? i) Suppose that nomina

Question

Suppose that the money demand is given by: Md = PY(0.25 ? i)
Suppose that nominal income is $100 and wealth is $500 and that the money supply is set by the central bank at ??s = 20.
a. Derive the demand for bonds.
b. Draw the supply and the demand of money
c. What is the equilibrium interest rate?
d. What happens to the interest rate if the money supply increases from 20 to 30? Illustrate your
answer graphically.
e. What happens to the interest rate if nominal income increases by 10%?
f. If the Federal Reserve Bank wants to increase the interest rate to 12%. At what level should it
set the supply of money?

Explanation / Answer

ms » Money Market Equilibrium Money Market Equilibrium This diagram shows the equilibrium interest rate in the money market. Equilibrium is where the supply of money is equal to the demand for money. Diagram: Money Market Equilibrium View larger version Any changes in the supply and demand for money will tend to raise or lower interest rates. For example, increased demand for money will tend to increase interest rates.

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