Suppose the private sector only hold currency (i.e. there are no banks). The demand for money is given by Money demand = $Y(0.4 - i)The nominal income is $100 and the supply of money is held fixed at 25. Starting from the initial equilibrium suppose nominal income increases to $125. The increase in income will ________ the demand for money and the new equilibrium interest rate will be ________ .Group of answer choicesincrease; 0.15increase; 0.2decrease; 0.1decrease; 0.05
Question
Suppose the private sector only hold currency (i.e. there are no banks). The demand for money is given by Money demand = 100 and the supply of money is held fixed at 25. Starting from the initial equilibrium suppose nominal income increases to $125. The increase in income will ________ the demand for money and the new equilibrium interest rate will be ________ .Group of answer choicesincrease; 0.15increase; 0.2decrease; 0.1decrease; 0.05
Solution
The increase in nominal income will increase the demand for money. This is because as income increases, people tend to hold more money for transaction purposes.
To find the new equilibrium interest rate, we need to set the new money demand equal to the fixed money supply and solve for the interest rate (i).
The new money demand is: Money demand = $125(0.4 - i)
Setting this equal to the fixed money supply ($25), we get:
25
Solving for i, we get:
i = 0.4 - (125) = 0.4 - 0.2 = 0.2
So, the increase in income will increase the demand for money and the new equilibrium interest rate will be 0.2.
Therefore, the correct answer is "increase; 0.2".
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