Question

QUESTION 2 (2,000 pts)

Suppose the market for real money balances in the Oesterling-Mack economy can be described by the following equation and value:

(M/P)^d = 0.5Y - 10,000r ;   (M/p) ^s = 800 ,and the nominal money supply is 1,600.

a)     Solve for the equation for the LM curve (call it LM₁).

b)    Consider the situation where the market for real money balances is in equilibrium. Calculate the real interest rate if the real GDP is 2,500. (Consider this as point A)

c)     Consider the situation where the market for real money balances is in equilibrium. Calculate the real interest rate if the real GDP is 3,300. (Consider this as point B)

Suppose the central bank decides to increase the real money supply to 1,200.

d)    Solve for the new equation for the LM curve (call it LM₂). You need not show the derivation here.

e)    Consider the situation where the market for real money balances is in equilibrium after the policy change. Calculate the real interest rate if the real GDP is 2,500. (Consider this as point C)

f)      Neatly sketch the LM curves from parts a and e, labeling them LM₁ and LM₂, respectively. Make sure to show points A, B, and C in the diagram.

Answer 1