The following table shows Alex's estimated annual benefits of holding different amounts of money. How much money will Alex hold if the nominal interest rate is 8 percent? (Assume she wants her money holdings to be in multiples of $100.)

Question

The following table shows Alex's estimated annual benefits of holding different amounts of money.  How much money will Alex hold if the nominal interest rate is 8 percent? (Assume she wants her money holdings to be in multiples of $100.)

Quizplus · Accepted Answer

Note that cost holding additional money is the nominal interest rate of 8 percent. So with each additional increase in money holding by $100, the extra cost is $8 (0.08 × $100) per year. Since the benefit is given as total values, we must compute the additional benefit as difference in total benefit. The additional benefit from increasing holdings from $700 to $800 is $9 (59 - 50) and $7 (66 - 59) when increasing holdings from $800 to $900. Since Alex's average money holding should only be increased if additional benefit exceeds the additional cost of $8, her money holding should be increased up until $800.

The Following Table Shows Alex's Estimated Annual Benefits of Holding