The following table shows Jay's estimated annual benefits of holding different amounts of money. How much money will Jay hold if the nominal interest rate is 4 percent? (Assume he wants his money holdings to be in multiples of $100.)

Question

The following table shows Jay's estimated annual benefits of holding different amounts of money.  How much money will Jay hold if the nominal interest rate is 4 percent? (Assume he wants his money holdings to be in multiples of $100.)

Quizplus · Accepted Answer

Note that cost holding additional money is the nominal interest rate of 4 percent. So with each additional increase in money holding by $100, the extra cost is $4 (0.04 × $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 $100 to $200 is $9 (29-20), $7 (36-29) when increasing holdings from $200 to $300, $5 (41- 36) when increasing holdings from $300 to $400, and $3 (44-41) when increasing holdings from $400 to $500). Since Jay's average money holding should only be increased if additional benefit exceeds the additional cost of $4, his money holding should be increased up until $400.

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