Answer to Question #305521 in Macroeconomics for blen

Question

Suppose that 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 2.A.     Assume that the price level is fixed. What happens to the equilibrium interest rate if the supply of money is raised from 1,000 to 1,200?

Answer 1

At Equilibrium,

M$_d$ = M$_s$ , so:

2(1000 - 100r) = 1000

r = 5%

If the price level is fixed and the supply of money is raised to 1200, then the equilibrium interest rate will be:

2(1000 - 100r) = 1200

r = 4%

With increase in money supply, the interest rate decreases from 5% to 4%