Question

Assume that the following data characterize the hypothetical economy of Trance: money supply = $200 billion; quantity of money demanded for transactions = $160 billion; quantity of money demanded as an asset = $10 billion at 12 percent interest, increasing by $10 billion for each 2-percentage-point fall in the interest rate.
a. What is the equilibrium interest rate in Trance? _____ percent.
b. At the equilibrium interest rate, what is the quantity of money supplied, the money demanded, the amount of money demanded for transaction, and the amount of money demanded as an asset in trace?
Quantity of money supplied = $ _____ billion
Quantity of money demanded = $ _____ billion
Amount of money demanded for transactions = $ _____ billion
Amount of money demanded as an asset = $_____ billion

Answer 1

Answer:

a. What is the equilibrium interest rate in Trance?

The equilibrium interest rate is 6%, because it is the interest rate that brings the money supply and the money demand to equilibrium.

At 12% interest rate, the quantity of money demanded is 170 billion, while the money supply is 200 billion.

The quantity of moned demanded as an asset increases by 10 billion if the interest rate falls by two percentage points. Thus, if the interest rate falls 6 percentage points, the quantity of money demanded as an asset will increase by 30 billion, reaching 40 billion.

At this point, money demand is:

$160 billion (money demanded for transactions) + $40 billion (money demanded as an asset) = $200 billion.

Which is the same as the money supply.

b. At the equilibrium interest rate, what is the quantity of money supplied, the money demanded, the amount of money demanded for transaction, and the amount of money demanded as an asset in trace?

The quantity of money supplied is still 200 billion.

The quantity of money demanded is 200 billion.

The amount of money demanded for transactions is 160 billion.

And the amount of money demanded as an asset is 40 billion.