Suppose, the money-demand equation is given by
MD = P× [(0.25 ×Y) ? (15 ×i)],where P is the price level, Y is the level of output in billions, and i is the interest rate in percentage points. Initially, P = 2, Y = $500, and i = 3. If Y rises to $600 and the price level does not change, by how much should the Fed change the money supply if it wants to keep the nominal interest rate unchanged? Should the money supply rise or fall, and by how much? Use the liquidity-preference framework and show a diagram of this situation.
What will be an ideal response?
The initial level of the money supply must be such that the quantity of money supplied equals the quantity of money demanded, so?
| S = 2 × [(0.25 × 500) ? (15 × 3)] = 160. |
| S = 2 × [(0.25 × 600) ? (15 × 3)] = 210. |
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