The following table shows Alex's estimated annual benefits of holding different amounts of money. $\begin{array}{|r|r|}
\hline{\text { Average money holdings }} & \text { Total benefit } \
\hline \$ 700 &\$50 \
\hline \$ 800 & \$ 59 \
\hline \$ 900 & \$ 66 \
\hline \$ 1,000 & \$ 71 \
\hline \$ 1,100 & \$ 72 \
\hline
\end{array}$
How much money will Alex hold if the nominal interest rate is 4 percent? (Assume she wants her money holdings to be in multiples of $100.)

Question

The following table shows Alex's estimated annual benefits of holding different amounts of money. $\begin{array}{|r|r|}
\hline{\text { Average money holdings }} & \text { Total benefit } \
\hline \$ 700 &\$50 \
\hline \$ 800 & \$ 59 \
\hline \$ 900 & \$ 66 \
\hline \$ 1,000 & \$ 71 \
\hline \$ 1,100 & \$ 72 \
\hline
\end{array}$  
How much money will Alex hold if the nominal interest rate is 4 percent? (Assume she wants her money holdings to be in multiples of $100.)

Quizplus · Accepted Answer

To determine the optimal amount of money Alex will hold, we need to find the point where the marginal benefit of holding additional money equals the marginal cost of holding that money. The marginal benefit is the increase in total benefit from holding an additional $100. The marginal cost is the interest forgone by not investing that $100 at the nominal interest rate of 4 percent, which is $4 ($100 * 4%). Looking at the table, the increase in total benefit from holding $900 to $1,000 is $5 ($71 - $66), which is closest to the marginal cost of $4. Beyond $1,000, the increase in total benefit drops to $1 ($72 - $71), which is less than the marginal cost. Therefore, Alex will hold $1,000.

The Following Table Shows Alex's Estimated Annual Benefits of Holding