Macroeconomics
Macroeconomics
10th Edition
ISBN: 9780134896441
Author: ABEL, Andrew B., BERNANKE, Ben, CROUSHORE, Dean Darrell
Publisher: PEARSON
Question
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Chapter 14, Problem 3NP

a.

To determine

To describe:

The reserve deposit ratio, the money multiplier and the money supply, and the real output Y at which a real interest rate of 0.10 clears the asset market.

a.

Expert Solution
Check Mark

Answer to Problem 3NP

The reserve deposit ratio is 20% , the money multiplier is 2.33 and the money supply is 140 . Real output Y is 282 .

Explanation of Solution

Given data,

res=0.4-2r

Currency deposit ratio is 0.4

Price level fixed at 1.0

Monetary base is 60

Real quantity of money demanded is L(Y,i)=0.5Y-10i

If r = i = 0.10

Expected inflation is zero

Nominal interest rate and real interest rate is equal.

Substitute the values from given data in the formula, we get:

res=0.4-2r=0.4-2×0.10=0.2

And,

Formula used to calculate money multiplier is given below:

MoneyMultiplier=c+1c+res

Substitute the value of c = 0.4 and res = 0.2, in the formula, we get:

MoneyMultiplier = c+1 c+res

= 0.4+1 0.4+0.2

= 1.4 0.6

=2.33

Now, the calculation of money supply is as follows:

Money Supply =( c+1 c+res )× Base

=2.33×60

=140

And, calculation of real output will be done as follows:

Here,

Ms = 140

L(Y,i)=0.5Y-10i

r = i = 0.10

Now, substitute the above value to the equation,

Ms=L(Y,i)=0.5Y-10i140=0.5Y-10×0.10140=0.5Y-10.5Y=141Y=282

Thus, the money supplier will be 140 , and the real output will be 282 .

Economics Concept Introduction

Introduction: The IS-LM model is an extended Keynesian model, in this graphic representation of IS-LM curve that helps in maintaining balance in the economy by establishing equilibrium between money supply and interest rates. This model is very useful macroeconomic tool for analysis of the money market and analysis of the goods market, which together helps in determining the equilibrium levels of interest rates and output in the economy in a given prices. It presents the set of all possible combinations of the GDP and interest rates, where the money supply and demand matches. Where, IS stands for Investment Savings and LM stands for Liquidity Money.

b.

To determine

To describe:

When. r = i = 0.05 , find the reserve deposit ratio, the money multiplier and the money supply, at what real output Y, a real interest rate of 0.10 clear the asset market.

b.

Expert Solution
Check Mark

Answer to Problem 3NP

The reserve deposit ratio is 30% , the money multiplier is 2 , the money supply is 120 and Real output Y is 241 .

Explanation of Solution

The formula to calculate reserve deposit ratio is as under:

res=0.4-2r

Given data,

r = i = 0.05

Substitute value r = 0.5, we get

res=0.4-2r=0.4-2×0.05=0.4-0.10=0.3

And, Money multiplier is calculated using the following formula:

MoneyMultiplier=c+1c+res

Substitute the value of c = 0.4 and res = 0.3, as calculated above.

=0.4+10.4+0.3=1.40.7=2

Now, substitute the value of money multiplier i.e. 2, in the formula of money supply:

MoneySupply=(c+1c+res)×Base

=2×60=120

And,

The formula to Calculate the real output would be done as under:

Ms=L(Y,i)

given,

Ms = 120

i = 0.05

120=0.5Y-10×0.05120=0.5Y-0.50.5Y=120.5Y=241

Thus, the money supplier will be 120 , and the real output will be 241 .

Economics Concept Introduction

Introduction: The IS-LM model is an extended Keynesian model, in this graphic representation of IS-LM curve that helps in maintaining balance in the economy by establishing equilibrium between money supply and interest rates. This model is very useful macroeconomic tool for analysis of the money market and analysis of the goods market, which together helps in determining the equilibrium levels of interest rates and output in the economy in a given prices. It presents the set of all possible combinations of the GDP and interest rates, where the money supply and demand matches. Where, IS stands for Investment Savings and LM stands for Liquidity Money.

c.

To determine

To describe:

If r = i = 0.054 , the output Y that clears the asset market clear in the case if the reserve deposit ratio is fixed at the value found in part (a) and is not affected by interest rates.

c.

Expert Solution
Check Mark

Answer to Problem 3NP

The asset market is clear in the case at output Y of 281 .

Explanation of Solution

In this case, the multiplier is unchanged from part a, which is at 2.33 , so the money supply is unchanged at 140 .

Given data,

M=140

i = 0.05

Substitute the above values in the equation:

MP=L  Gives,

1401=0.5Y-(10×0.05)140+0.5=0.5YY=281

Economics Concept Introduction

Introduction: The IS-LM model is an extended Keynesian model, in this graphic representation of IS-LM curve that helps in maintaining balance in the economy by establishing equilibrium between money supply and interest rates. This model is very useful macroeconomic tool for analysis of the money market and analysis of the goods market, which together helps in determining the equilibrium levels of interest rates and output in the economy in a given prices. It presents the set of all possible combinations of the GDP and interest rates, where the money supply and demand matches. Where, IS stands for Investment Savings and LM stands for Liquidity Money.

d.

To determine

To examine:

Whether the impact on LM curve is flatter or steeper when the reserve deposit ratio depends on the real interest rate than when it is fixed.

d.

Expert Solution
Check Mark

Answer to Problem 3NP

If the reserve deposit ratio is unaffected by the real interest rate, the LM curve is steeper than when it is affected by the real interest rate.

Explanation of Solution

Supposing there is a reduction in the interest rates, it will lead to lowering of the reserves for the banks. This means, a high reserve ratio will lead to lowering of money multiplier and thereby reducing the nominal money supply. Therefore, the LM curve will be steeper when it is unaffected by the real interest rate more than that of when affected by the real interest rate.

Economics Concept Introduction

Introduction: The IS-LM model is an extended Keynesian model, in this graphic representation of IS-LM curve that helps in maintaining balance in the economy by establishing equilibrium between money supply and interest rates. This model is very useful macroeconomic tool for analysis of the money market and analysis of the goods market, which together helps in determining the equilibrium levels of interest rates and output in the economy in a given prices. It presents the set of all possible combinations of the GDP and interest rates, where the money supply and demand matches. Where, IS stands for Investment Savings and LM stands for Liquidity Money.

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Students have asked these similar questions
Q1. Suppose that money demand is given by the following function MD=$Y (0.5 - i) and that nominal GDP is given by $200. Moreover, assume that the monetary base is given by H³ = $8. It is also known that people in this economy hold all their wealth either in form of checkable deposits or in form of bonds (i.e. people hold no currency) and that banks must hold 10% of the checkable deposits as reserves. (a) Calculate the money market equilibrium using that the supply and the demand for central bank money is equal. (b) Calculate the overall supply of money. (c) What happens to the money market equilibrium if the central bank decides to increase the monetary base to Hs = $9? (d) What are the effects on the overall money supply in the economy? (Calculate the new overall supply of money and explain your result.)
In class we assumed that money demand depends upon income, Md = L(Y, i). However, if people hold money as a medium of exchange it may be that money demand really should depend upon consumption, Md = L(C, i). In other words, if people consume more, they will also want to hold more money. Suppose that consumption, as usual, depends upon disposable income, C = C(Y – T). Money demand will then also, indirectly, depend upon disposable income, Md = L[C(y - T), i]. True or False: In this case, a tax cut will always increase in the short run
Suppose that the demand for money is given by the following equation: MD  = $Y (0.25 – 0.8i) Assume that nominal income ($Y) is $5,000 billion. Determine the equilibrium level of the interest rate if the money supply is $900 billion. Suppose the central bank increases the money supply to $950 billion. Determine the new equilibrium interest rate. Suppose we have the original money supply (in part a) and that the level of nominal income increases to $6,250 billion. Determine the equilibrium interest rate.
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