Suppose the real money demand function is Mᵈ/P = 2000 + 0.2Y - 10,000 (i - iᵐ).Assume M = 5000,P = 2.0,iᵐ = .04,and πᵉ = .03.If Y were to increase from 4000 to 5000,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 and P = 2.0, the real money supply is M/P = 2500. Initially, with Y = 4000, set Mᵈ/P = M/P to find the initial interest rate. Then, increase Y to 5000 and solve again. The difference in the interest rates gives the increase in percentage points. The calculation shows an increase of 2 percentage points.

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