Problem 5 part b and c

Problem 5 part b and c - supply increases from 1000 to...

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(6 th Edition, Mankiw) Demand for Real Money Balances: (M/P) d = 1000 – 100 r Nominal Money Supply: M = 1000 Price Level: P = 2 Part b – Find the equilibrium real interest rate. In order to find the equilibrium real interest rate, set the Real Money Supply equal to the Real Money Demand. Real Money Supply = Real Money Demand (M/P) s = (M/P) d (1000 / 2) = 1000 – 100 r 500 = 1000 – 100 r -500 = - 100 r 5 = r This means that equilibrium real interest rate is 5%. Part c – what happens to the equilibrium real interest rate if the nominal money
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Unformatted text preview: supply increases from 1000 to 1200, while the price level remains constant? Money Supply = Money Demand (M/P) s = (M/P) d (1200 / 2) = 1000 100 r 600 = 1000 100 r -400 = - 100 r 4 = r The new equilibrium interest rate is now 4%. Does this make sense? Well, if the nominal money supply is increased, ceteris paribus, you would expect the real interest rate to drop. This gives a result consistent with the theory....
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