Chapter 1. Chapter 11 – Question 5

Step 1

Work It Out
true
true
You must read each slide, and complete any questions on the slide, in sequence.

Question

Suppose that the money demand function is

(M/P)d= 1,000 – 100r,

where r is the interest rate in percent. The money supply M is 1,000 and the price level P is fixed at 2.

a. Below is the graph of supply and demand for real money balances.

What is the equilibrium interest rate?

The vertical axis is labeled “r” or the interest rate, and the horizontal axis is labeled “M/P”, or real balances. The supply for real balances is a vertical line at the value 500. The demand for real balances is a negatively sloped line, with a slope of -100. This line intersects the vertical axis at r = 10, and the horizontal axis at real balances of 1000.

The equilibrium interest rate, r, equals DYU2tVvtzEQ=%.

Review pages 327-329, along with Figure 11-9, for a discussion of equilibrium in the money market.
1:58

Step 2

Question

Suppose that the money demand function is

(M/P)d= 1,000 – 100r,

where r is the interest rate in percent. The money supply M is 1,000 and the price level P is fixed at 2.

b. What happens to the equilibrium interest rate if the supply of money is raised from 1,000 to 1,200?

The equilibrium interest rate, r, equals h4XZagboIgc=%.

Review pages 327-330, along with Figure 11-9 and Figure 11-10, for a discussion of equilibrium in the money market. See also the Case Study “Does a Monetary Tightening Raise or Lower Interest Rates.”

Question

c. If the central bank wants the interest rate to be 7 percent, what money supply should it set?

The central bank should set the money supply equal to Y4X9gzy3nmw=

Review pages 327-330, along with Figure 11-9 and Figure 11-10, for a discussion of equilibrium in the money market. See also the Case Study “Does a Monetary Tightening Raise or Lower Interest Rates.”
1:07