Workbook

For Chapter 4
Of Blanchard Macroeconomics.

Problem 2

Suppose that a persons wealth is $50,000 and that her yearly income is $60,000. Also,
suppose that her money demand function is given by
M
d
= $Y(0.35 i)

a. What is her demand for money if the interest rate is 5%? Substituting 0.05
for i in the money demand function, M
d
(5%) = _____________. What if
the interest rate is 10%? _______. Weve assumed that wealth can be
divided among two assets, and only two: money and bonds. Given the
demands for money you just found, what is the demand for bonds when
i=5%? ________ When i=10%?________.
b. What is the effect of interest rates on money demand? ________________
_______________________________________. Why do you think this
happens?_________________________________________________________
_________________________________________________________________
________________________________________________________________.
c. Notice that M
d
= $Y(0.35 i). Suppose that the interest rate is 10%.
Suppose that yearly income is reduced by 50%. By what percentage (and
in what direction) will money demand change? ______________________.
d. Suppose that the interest rate is 5%. Suppose that yearly income is
reduced by 50%. By what percentage (and in what direction) will money
demand change? ______________________.
e. Given your two answers above, how does the interest rate affect the effect
of income on money demand? ______________________________________
________________________________________________________________.





Problem 4

Suppose that money demand is given by
M
d
= $Y(0.25 i)

where $Y is $100. Also, suppose that the supply of money is $20. Assume equilibrium
in financial markets.

a. Equilibrium in financial markets is found where M
s
= M
d
. Doing this
results in this equilibrium condition _________________. Now plug in the
value of $Y into the equation_________________. The only remaining
unknown is the interest rate. To find out what it is, solve this equation
for i = __________________. This gives a value of ________.
b. Suppose the Federal Reserve wants to increase i by 10 percentage points,
say, from 2 to 12%. To do that, it will decrease the supply of money.
Given your answer to (a) what is the new, desired level of the interest
rate? _________. Using the equation for i you found above, what is the
level of M
s
that will generate that interest rate? M
s
= ___________.

Dr. Gabriel Martinez Academic 2056
gmartinez@avemaria.edu (239) 280-1611