Assume that the money demand function is left parenthesis (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:

Question

Assume that the money demand function is left parenthesis (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:

BlackTom AI · Accepted Answer

We begin by restating the problem and listing the answer choices so we can analyze each option.
Question: Assume 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:
Answer options:
- a. drop by 4 percent.
- b. drop by 2 percent.
- c. drop by 1 percent.
- d. remain unchanged.

Now we evaluate the options by using the money market equilibrium condition (M/P)d = (M/P)s.
First, compute the real money balances (M/P) for each scenario:
- Initially, with M = 2,000 and P = 2, real money balances are M/P = 2000/2 = 1,000.
- After the policy change, with M = 2,800 and P = 2, real money balances are M/P = 2800/2 = 1,400.

Next, use the money demand function to find the equilibrium r in each case.
- Initial equilibrium: (M/P)d = 1,000 = 2,200 − 200r ⇒ 200r = 2,200 − 1,000 = 1,200 ⇒ r = 6%.
- New equilibrium after increase in money supply: (M/P)d = 1,400 = 2,200 − 200r ⇒ 200r = 2,200 − 1,400 = 800 ⇒ r = 4%.

Now analyze each option in light of these calculations:
- Option a: "drop by 4 percent." This would imply r falls from 6% to 2%. The computed new rate is 4%, not 2%, so this option misstates both the magnitude and the direction relative to the actual result. It is not consistent with the calculation.
- Option b: "drop by 2 percent." This describes a decline from 6% to 4%, which matches the computed change in the interest rate exactly. The magnitude of the drop is 2 percentage points, which is indeed a 2 percentage point decrease (and commonly referred to as a 2 percent drop in the context of percentage points).
- Option c: "drop by 1 percent." This would imply a new rate of 5%, which does not align with the calculated 4% given the real money balances after the policy change. The mismatch shows a miscalculation of the sensitivity of r to the shift in M.
- Option d: "remain unchanged." Since the real money balances rose from 1,000 to 1,400, the money market is no longer in the same equilibrium, so the interest rate must adjust. Therefore, this option is contradicted by the calculation.

In summary, option b aligns with the algebraic steps: increasing the money supply raises real balances from 1,000 to 1,400, which, via (M/P)d = 2,200 − 200r, lowers r from 6% to 4%. The other choices fail because they either overstate or understate the magnitude of the decrease, or ignore the necessary adjustment implied by the new money balance.

BU.220.610.51.FA25 M8 Final Comprehensive Exam - Multiple Choice Questions- Requires Respondus LockDown Browser

Assume that the money demand function is left parenthesis (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:

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BU.220.610.51.FA25 M8 Final Comprehensive Exam - Multiple Choice Questions- Requires Respondus LockDown Browser

Assume that the money demand function is left parenthesis (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:

View Explanation

Log in for full answers

Similar Questions

Exhibit: Market for Real Money Balances Based on the graph, if the interest rate is r3, then people will ______ bonds and the interest rate will ______.

(Figure: Money Market I) Use Figure: Money Market I. If the interest rate is at rL, and the central bank neither buys nor sells Treasury bills, then the interest rate will:

In the figure above, the decrease in the interest rate from i1 to i2 can be explained by ________.

In the market for money, an interest rate below equilibrium results in an excess ________ money and the interest rate will ________.

Figure 31-1 ​ Refer to Figure 31-1. When the money supply curve shifts from MS1 to MS2,

If the money market is initially in equilibrium at point E, and the central bank sells Treasury bills, then the interest rate will:

More Practical Tools for Students Powered by AI Study Helper

Making Your Study Simpler

Exhibit: Market for Real Money Balances Based on the graph, if the interest rate is r3, then people will bonds and the interest rate will .

In the market for money, an interest rate below equilibrium results in an excess money and the interest rate will .

Figure 31-1 Refer to Figure 31-1. When the money supply curve shifts from MS1 to MS2,