Suppose the real money demand function is M^d/P = 2000 + 0.2Y - 10,000^{(i - i}^m⁾. Assume M = 5000, P = 2.0, i^m = .04, and π^e = .03. If Y were to increase from 4000 to 5000, then the real interest rate would increase by how many percentage points?

Question

Quizplus · Accepted Answer

The real money demand function is given by M/P = 2000 + 0.2Y - 10,000(i - i^m). With M = 5000 and P = 2.0, the real money supply is 2500. Initially, with Y = 4000, solve for i: 2500 = 2000 + 0.2(4000) - 10,000(i - 0.04). Solving gives i = 0.05. When Y increases to 5000, solve again: 2500 = 2000 + 0.2(5000) - 10,000(i - 0.04). Solving gives i = 0.07. The real interest rate increases by 2 percentage points (0.07 - 0.05).

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

Suppose the Real Money Demand Function Is M^d/P = 2000