Suppose the real money demand function is Mᵈ/P = 2000 + 0.2Y - 10,000 (i - iᵐ).Assume M = 4000,P = 2.0,iᵐ = .04,πᵉ = .03,and Y = 5000.The real interest rate that clears the asset market is

Question

Quizplus · Accepted Answer

First, we need to calculate the expected inflation rate (πᵉ) adjusted interest rate, which is:

i - πᵉ = i - 0.03

Then we can substitute the given values into the real money demand function as follows:

Mᵈ/P = 2000 + 0.2Y - 10,000(i - iᵐ)

4000/2.0 = 2000 + 0.2(5000) - 10,000(i - 0.04)

2000 = 2000 + 1000 - 10,000(i - 0.04)

1000 = 10,000(0.04 - i)

-0.1 = - i + 0.04

i = 0.14 or 14%

Therefore, the real interest rate that clears the asset market is 14%, which means that the answer is C.

Suppose the Real Money Demand Function Is Mᵈ/P = 2000