Question

Assume the real money demand function is L(Y;i)=2000+0.3Y-5000i where Y is real output, P is the...

Assume the real money demand function is

L(Y;i)=2000+0.3Y-5000i

where Y is real output, P is the price level, i is the nominal interest rate on non-monetary assets and monetary assets earn no interest.

a) Assuming that the asset market is in equilibrium at i=0.05. Find equilibrium levels of real money supply, nominal money supply, and the velocity of money if P=100, and

Y=2000.

b) Find the real income elasticity of money demand at the equilibrium level of money balances found in previous part.

c) The rate of inflation in this economy is defined as the growth rate of the nominal money supply minus an adjustment for the growth rate of real money demand arising

from growth in real output: π=∆M/M - ηy(∆Y/Y

Assuming that real income is expected to grow by 5% over the next year, and the interest rate remain constant. Find out by how much should the central bank increase the money supply if pursuing an ination targeting policy to maintain a zero ination rate for next year.

d) Does the quantity theory of money hold in this economy? state your reason by considering above part

Homework Answers

Answer #1

a) Real Money Supply = M/P. Using i= 0.05 and Y= 2000.

M = 2000 + 0.3*2000 -5000*0.05

M = 2350

Real money supply must be 2350

Nominal money supply = 2350*100 = $235000.

Velocity = (P*Y)/M

Velocity = 85.10

b) Real income elasticity of money = dL/di * (i/L)

Elasticity = -5000* (0.05/2350)

Elasticity = -0.106

c) The central bank will increase the money supply by 0.05*235000 = 11750

* For solution to other parts please post as a new question . CAn solve only these many parts

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Suppose the demand for real money balances is Md/P = L(Y, i), where L(Y, i) is...
Suppose the demand for real money balances is Md/P = L(Y, i), where L(Y, i) is an increasing function of income Y and a decreasing function of the nominal inter- est rate i. Assume that the interest elasticity of money demand is infinite when the nominal interest rate is zero. Money-market equilibrium is represented by the equation Ms/P = L(Y, i), where Ms is the money supply controlled by the central bank and P is the price level. The LM...
1 Assume that the demand for real money balance (M/P) is M/P = 0.6Y – 100i,...
1 Assume that the demand for real money balance (M/P) is M/P = 0.6Y – 100i, where Y is national income and i is the nominal interest rate (in percent). The real interest rate r is fixed at 3 percent by the investment and saving functions. The expected inflation rate equals the rate of nominal money growth. a. If Y is 1,000, M is 100, and the growth rate of nominal money is 1 percent, what must i and P...
Suppose that the money demand function takes the form (M/P)d = L (i, Y) = Y/(5i)...
Suppose that the money demand function takes the form (M/P)d = L (i, Y) = Y/(5i) a. If output grows at rate g and the nominal interest rate is constant, at what rate will the demand for real balances grow? b. What is the velocity of money in this economy? c. If inflation and nominal interest rates are constant, at what rate, if any, will velocity grow? d. How will a permanent (once-and-for-all) increase in the level of interest rates...
Suppose that the real money demand function is L(Y, r+πe)=0.01Yr+πe ,L(Y, r+πe)=0.01Yr+πe , where YY is...
Suppose that the real money demand function is L(Y, r+πe)=0.01Yr+πe ,L(Y, r+πe)=0.01Yr+πe , where YY is real output, rr is the real interest rate, and πeπe is the expected rate of inflation. Real output is constant over time at Y=150Y=150. The real interest rate is fixed in the goods market at r=0.05r=0.05 per year. Suppose that the nominal money supply is growing at the rate of 10% per year and that this growth rate is expected to persist forever. Currently,...
In Freedonia the real demand for money is d = (M/P)d = L(i,Y) = Y/(5i1/3 ),...
In Freedonia the real demand for money is d = (M/P)d = L(i,Y) = Y/(5i1/3 ), i being the nominal interest rate. (a) What is the income velocity of money in Freedonia? (b) Suppose output is growing at the annual rate of g. What is the growth rate of real money demand? (c) If the nominal interest rate is constant, what is the growth rate of velocity? (d) Suppose at time 1 there is a permanent increase in i. What...
Consider an economy in which the money demand function takes the form: (M/P) d = L...
Consider an economy in which the money demand function takes the form: (M/P) d = L (i, Y) = Y/(5i) a. If output grows at rate g, at what rate will the demand for real balances grow (assuming constant nominal interest rates)? b. What is the velocity of money in this economy? c. If inflation and nominal interest rates are constant, at what rate, if any, will velocity grow? d. How will a permanent (once-and-for-all) increase in the level of...
Assume that the demand for real money balance, (M/P) d = 0.5Y – 200i, where Y...
Assume that the demand for real money balance, (M/P) d = 0.5Y – 200i, where Y is national income and i is the nominal interest rate (in percent). The real interest rate r is fixed at 2 percent by the investment and saving functions. The expected inflation rate is 1 percent, real GDP is 5,000 and the money supply is 209,110. a. What is the nominal interest rate? b. What is the price level? c. Now suppose Y is 2,000,...
Assume that the real money balance (M/P) is M/P=0.6Y-100i, where Y is the national income and...
Assume that the real money balance (M/P) is M/P=0.6Y-100i, where Y is the national income and I is the nominal interest rate. The real interest rate "r" is fixed at 3 percent by the investment and saving functions. The expected inflation rate equals the rate of nominal money growth. -If Y is 1,000, M is 100, and the growth rate of nominal money is 2.5%, what must "i" and "P" be? -If Y is 1,000, M is 100 and the...
The real money demand curve is given by: L d (R, Y ) = 0.5Y −...
The real money demand curve is given by: L d (R, Y ) = 0.5Y − 100R − 20 where Y is the real GDP and R refers to the interest rate. The initial monetary base level MB = 100. The initial money supply level Ms = 200, price level P = 10 and initial output level Y = 100. 1. Calculate the initial money multiplier and equilibrium interest rate. The Fed increases the monetary base by 10% through open...
Assuming output Y is determined exogenously, and demand for real money balances is given by (M/P)...
Assuming output Y is determined exogenously, and demand for real money balances is given by (M/P) d = kY , answer the following: (a) Suppose k changes from period to period. Using the quantity equation MV = P Y , show how inflation is related to money growth, output growth, and growth in k. (b) Holding the money supply M and output Y constant, does a fall in k lead to inflation, deflation, or no change in the price level?...