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:

Answer 1

Answer: The nominal money supply should set at 1,600.

Explanation:

Given that,

Money demand function: (M/P)d = 2,200 – 200r

r - Interest rate

Money supply (M) = 2,000

Price level (P) = 2

If the fed wants to set the interest rate at 7% then,

Money supply = money demand

$(\frac{M}{P})^{s}$ = $(\frac{M}{P})^{d}$

$\frac{M}{P}$ = 2,200 – 200r

P = 2 and r = 7%

$\frac{M}{2}$ = 2,200 – 200 × 7

                            M = 800 × 2

                            M = 1,600

The nominal money supply should set at 1,600.