Suppose the real money demand function is
Md/P = 2400 + 0.2 Y - 10,000 (r + ?e).
Assume M = 5000,?e = .03,and Y = 5000.If the price level were to decrease from 2.5 to 2.0,then the real interest rate would decrease by how many percentage points (assuming Md/,?e,and Y are unchanged)?

Question

Quizplus · Accepted Answer

First, we need to calculate the initial real interest rate, given the values provided:
Md/P = 2400 + 0.2 Y - 10,000 (r + ?e)
Md/P = 2400 + 0.2 (5000) - 10,000 (r + 0.03)
5000 = 2400 + 1000 - 10,000 (r + 0.03)
2600 = 10,000 (r + 0.03)
r = 0.027

Next, we need to calculate the new real interest rate after the price level decreases from 2.5 to 2.0:
Md/P = 2400 + 0.2 Y - 10,000 (r + ?e)
Md/2.0 = 2400 + 0.2 (5000) - 10,000 (r + 0.03)
5000 = 2400 + 1000 - 8000 (r + 0.03)
4200 = 8000 (r + 0.03)
r = 0.02125

The decrease in the real interest rate can be calculated as follows:
0.027 - 0.02125 = 0.00575 or 5.75%
However, we need to round to the nearest whole number, which gives us an answer of 5. Therefore, the best choice is B) 5.

Suppose the Real Money Demand Function Is