Question

Assume that money demand function is followed by the equation:
??=100−10?+0.5?
Md=Money demand
r= interest rate
Y= real income
a. In the money demand equation why is the sign of interest rate is negative and the sign of real income is positive, explain.
b. If real income is 800 billion TL and interest rate is %10 what is the quantity of money demand?
c. If equilibrium interest rate is %5 and real income is constant (Y=800 billion TL) what is the quantity of money supply?
d. Draw the money market equilibrium when the equilibrium interest rate is %5.

Answer 1

Solution:

Money demand is the amount of money that people desire to hold in form of cash.

There are three motives for money demand-

1) Transactive motive- The money demanded by people to keep for daily transaction purposes is called Transactive motive for money.

2) Precautionary purpose- Money demanded for emergency purposes is called precautionary motive.

3) Speculative purpose- Money demanded for investing in bonds, shares etc that is where a person gets some return is called Speculative motive for demand for money.

1) There is a negative relationship between interest rates and demand for money because as interest rate rises, people tend to hold less money for speculative purposes and deposit their money in banks. Thus as interest rate rises speculative demand for money falls.

There is a positive relationship between income level and demand for money because as income of people increases their demand for transaction purposes also increase. Thereby, there is a positive relationship between income level and transactive motive for money demand.

2) Given -

Y= 800 billion TL

r=10%

So Money demand is calculated as shown below-

C) At equilibrium, money supply is equal to money demand.

d) the diagram is as follows-