Assume that the money demand function is (M/P)^d = 2,200

Question

Assume that the money demand function is (M/P)^d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is 2. If the price level is fixed and the Fed wants to fix the interest rate at 7 percent, it should set the money supply at: A) 2,000. B) 1,800. C) 1,600. D) 1,400.

Quizplus · Accepted Answer

To fix the interest rate at 7 percent, we need to equate the money demand function to the money supply and solve for the interest rate.

2,200 - 200r = 2,000/2*7

2,200 - 200r = 143.6

200r = 2,056.4

r = 10.282%

The interest rate that results from the given money supply is higher than the desired interest rate of 7 percent. To bring the interest rate down to 7 percent, the Fed needs to increase the money supply.

We can rearrange the money demand function to solve for the money supply:

M = (2,200 - 200r) * P / U1 * P1 * S1 * S1

M = (2,200 - 200 * 7) * 2 / 1 * 1 * 1 * 1

M = 1,600

Therefore, the Fed should set the money supply at 1,600 to fix the interest rate at 7 percent.

Assume That the Money Demand Function Is (M/P)d = 2,200