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 supply of money is raised to 2,800, then the equilibrium interest rate will:

A. drop by 4 percent
B. drop by 2 percent
C. drop by 1 percent
D. remain unchanged

Answer 1

drop by 2 percent

Explanation: Given that :

M =2000

P= 2

( M/P )d = 2200 - 200r

2000/2 = 2200 - 200r

1000 = 2200 - 200r

2200-1000 = 200r

1200 = 200r

r = 1200/200

r = 6

When M = 2800

( M/P )d = 2200 - 200r

2800/2 = 2200 - 200r

1600 = 2200 - 200r

2200-1600 = 200r

600 = 200r

r = 600/200

r = 3

The equilibrium interest rate will:

Rate when m = 2000/ Rate when m = 2800

6/3 = 2