Suppose the real money demand function is
Md/P = 2400 + 0.2 Y - 10,000 (r + ?e).
Assume M = 5000,P = 2.0,and ?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 Md/P = 2400 + 0.2Y - 10,000(r + ?e). Given M = 5000 and P = 2.0, the real money supply is 5000/2 = 2500. Initially, with Y = 4000, the equation becomes 2500 = 2400 + 0.2(4000) - 10,000(r + 0.03). Solving for r gives r = 0.05. When Y increases to 5000, the equation becomes 2500 = 2400 + 0.2(5000) - 10,000(r + 0.03). Solving for r gives r = 0.07. The increase in the real interest rate is 0.07 - 0.05 = 0.02, or 2 percentage points.

Suppose the Real Money Demand Function Is