Given a value of the money supply that the Fed chooses, the equilibrium interest rate can...

Given a value of the money supply that the Fed chooses, the equilibrium interest rate can be read off of the money demand schedule. The quantity of money demanded (Md) depends negatively on the interest rate. An increase in P and/or Y shifts the money demand curve to the right. Assume that the inverse money demand is given as r = (10+Y) -0.05 Md. Y =$19.1 (trillion) and Ms=581.1. Using Excel create a spreadsheet with the column headings Ms, r, Md, and M*P. Let’s sstart with no inflation, i.e., P=1.00. Fill in the spreadsheet’s cells for r= 0.035 to r=0.060 in increments of 0.001. (Note: All your answers should be rounded to the nearest thousandth (third digits after the decimal point. Ex: 0.0143 =>0.014, 0.1866=> 0.187) What is the equilibrium interest rate? ______ How much of the money is demanded by the economy at the equilibrium interest rate? ______ Assume that the nation’s GDP increased from 19.1 to 19.2. What happens in the money market at the existing interest rate? ______ (shortage or surplus) of money by $ ______ What is the eventual interest rate as a result of increase in GDP? ______ Assume that the price level increased by 0.5% during the year. GDP remains at $19.1 (trillion). What happens in the money market at the existing interest rate? ______ (shortage or surplus) of money by $ ______.

Expert Solution

r = (10 + Y) - 0.05 Md -----------------------------------------------------------------------(Equation 1)

=> 0.05 Md = (10 + Y) - r

=> Md = (10 + Y - r) / 0.05 -----------------------------------------------------------------(Equation 2)

1. What is the equilibrium interest rate? 0.045

Explanation: Using equation 2, Md = 581.1 with Y = 19.1 and r = 0.045 and Md = Ms = 581.1. Hence, the equilibrium interest rate = 0.045.

2. How much of the money is demanded by the economy at the equilibrium interest rate? 581.1

Explanation: At the equilibrium, Md = Ms. As shown above, at equilibrium money demanded = 581.1.

3. Assume that the nation’s GDP increased from 19.1 to 19.2. What happens in the money market
at the existing interest rate? Md rises to 583.1 and shortage of money by $ 2

Explanation: Using equation 2, Md = 583.1 when Y = 19.2 at equilibrium interest rate = 0.045. Here Md (583.1) > Ms (581.1). Hence shortage of money supply = 583.1 - 581.1 = 2

4. What is the eventual interest rate as a result of increase in GDP? 0.145

Explanation: With Y = 19.2, and Md = Ms = 581.1, the interest rate can be derived from equation 1 as (10+19.2)-0.05(581.1) = 0.145. Hence, eventually interest rate rises to 0.145 due to increase in nation's GDP from 19.1 to 19.2, other things remaining constant.

5. Assume that the price level increased by 0.5% during the year. GDP remains at $19.1 (trillion).
What happens in the money market at the existing interest rate? Real Ms falls to 578.209 and shortage of money by $ 4.891

Explanation: Due to increase in price level by 0.5% (i.e., new price level = 1.005), the real money supply becomes 581.1/1.005 = 578.209. Using equation 2, Md = 583.1 (using Y = 19.2 and r = 0.045). Since Md (583.1) > real Ms (578.209), shortage in money supply = 4.891.

Rahul Sunny answered 17 hours ago

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