Suppose the real money demand function is Mᵈ/P = 2000 + 0.2Y - 10,000 (i - iᵐ).Assume M = 5000,iᵐ = .04,πᵉ = .03,and Y = 5000.If the price level were to increase from 2.0 to 2.5,then the real interest rate would increase by how many percentage points?

Question

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The real money demand function is Mᵈ/P = 2000 + 0.2Y - 10,000(i - iᵐ). Given M = 5000, iᵐ = 0.04, πᵉ = 0.03, and Y = 5000, we first calculate the initial real interest rate when P = 2.0. Solving for i, we find i = 0.09. When P increases to 2.5, the new real interest rate is i = 0.14. The increase in the real interest rate is 0.14 - 0.09 = 0.05, or 5 percentage points.

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