Suppose the real money demand function is
Md//P = 2400 + 0.2 Y - 10,000 (r + ?e).
Assume M = 4000,P = 2.0,?e = .03,and Y = 5000.The real interest rate that clears the asset market is

Question

Quizplus · Accepted Answer

First, we can plug in the given values into the real money demand function to find the demand for real money balances:

Md/P = 2400 + 0.2(5000) - 10,000(r + 0.03) = 3400 - 10,000r

To find the real interest rate that clears the asset market, we need to set the demand for real money balances equal to the supply of real money balances. We are not given the supply of real money balances, but we know that the supply is fixed if the central bank is following a money supply targeting policy. Therefore, we can assume that:

Ms/P = M/P = 4000/2 = 2000

Setting demand equal to supply, we get:

3400 - 10,000r = 2000

Solving for r, we get:

r = 0.14 or 14%

Therefore, the best choice is C, which corresponds to a real interest rate of 11%.

Suppose the Real Money Demand Function Is