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Fall-14 Econ-2

Sec. #0720 Homework Assignment - 2 Interest Rate and Monetary Policy

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Assume that the following data characterize the hypothetical economy of Greatcy: money supply = $210 billion; quantity of money demanded for transactions = $150 billion; quantity of money demanded as an asset = $10 billion at 12 percent interest, increasing by $10 billion for each 2-percentage-point fall in the interest rate. 1. Present the data graphically using the space provided on the left. Properly label the graph. 2. What is the equilibrium interest rate in Greatcy?

3. At the equilibrium interest rate, what are the quantity of money supplied, the total quantity of money demanded, the amount of money demanded for transactions, and the amount of money demanded as an asset in Greatcy? Quantity of money (M) supplied = $_______ Total quantity of money (M) demanded = $______ Amount of M demanded for transactions = $______ Amount of M demanded as an asset = $______

Refer to the table for Roolanda: Money Supply $500 500 500 500 500 Money Demand $800 700 600 500 400 Interest Rate 2% 3% 4% 5% 6% Investment at Interest $80 70 60 50 40 Potential Real GDP $350 350 350 350 350 Actual Real GDP at Interest $390 370 350 330 310

4. Answer the following questions: What is the equilibrium interest rate in Roolanda? __________________ What is the level of investment at the equilibrium interest rate? ______________ Is there either a recessionary output gap (negative GDP gap) or an inflationary output gap (positive GDP gap) at the ongoing equilibrium interest rate and, if either, what is the amount?_____________________________________ Given money demand, by how much would the Roolanda's central bank need to change the money supply to close the output gap? ________________________ What will be the new interest rate in Roolanda?_________ What is the size

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