Question 2: (20 points)

Consider the Money Market characterized by the following data:

Part 1: Calculate Total Demand for Money to complete the table below if Transactions and
Precautionary Demand for Money at the given level of income (Y) and the general price
level (P) is MoTP = 6,835.

Interest Asset Demand for Total Demand for Money:

Question
Rate Money (MDA) MD = MDA + MoTP
Number

I Part l(a) 20 1,805 II

Part l(b) 18 3,227. II
Part 1(c) 16 4,499 I
Part l(d) 14 5,621 I
I
Part l(e) 12 6,594 I

Part l(f) 10 I 7,417 I

Part 2: Given the Total Money Demand schedule in your table above, determine the
equilibrium interest rate if the money supply is 8,640: _ _ _ _ _ %.

Part 3: Suppose Transactions Demand for Money fell by 4789. Calculate the new
Transactions and Precautionary Demand for money, (MoTP_2): _ _ _ __

Part 4: Based on the new Transactions and Precautionary demand for money you calculated
in Part 3 above, calculate Total Demand for Money at all interest rates to complete the table
below:

Question Interest Asset Demand for Total Demand for Money:

Number Rate Money (MDA)
-
MD 2 = MDA + MorP-2
Part 4(a) II 20 II 1,805 I
l
Part 4(b) 18 3,227 I
I I 11

I Part 4(c) II 16 11
4,499 I
 .

Qu est ion Int ere st Ass et Dem and for Tot al Dem and for Mo ney :

Number Rat e Mo ney (MD A) MD 2- = MDA + Morp 2-

I Par t 4(d ) JI
14 II
5,6 21 II
I
I Par t 4(e ) II
12 II 6,5 94 II
I Par t 4(f ) II 10 II 7,4 17 II

ine the new equ ilibr ium inte res t rate assuming the Central Bank kept the
Par t 5: Determ
_ _ _ _ 0/4
mo ney sup ply unchanged at 8,640: _

e the
and for money, the Central Bank can rais
Par t 6: At the public's new low er dem _
inte res t rate bac k to the orig inal equ ilibrium level (Part 2 above) by _ _ _
equ ilibr ium
from _ _ _ _ _ to _ _ _ __
the Mo ney Sup ply by _ _ _ _ _
 Exercise 12.1: The Monetary Transmission Mechanism
Suppose the Bank of Canada's purchase of Federal Government bonds from Commercial Banks raised the
Money Supply from 412 to 457. Use the four-panel Graph of the Monetary Transmission Mechanism to
answer the questions that follow. The economy's original equilibrium is denoted point A in each panel.

The Monetary (Policy) Transmission Mechanism

9'and 1: 5/'re .Mmwi f/'and, 2: 3 ,we,oftnent 9>enuuul
•

6%

4% .
I
I

! B
3% ··-·- -·-t---
! I I •

2% ~----4--+------+---- ,c
I l :

.. ..
I
I
:
t
r
t ...
•
I
I

i : I

412 457 277 289 306 327

Quantity_of_Money Business_Investment_Expenditures

fl'mul 3: (lggwgau & p ~ ffand, 4: {lggltegau 9>emand SuppbJ

AE=Y p LRAS SRAS1
AE _, AE2 I
\ / SRA.So
AEl ' \ ,I
'' ,,
611 '
109 ------
105.3 -------
101.6 -- __ ,..:- -1-!. AD }
AO _, I .._

0
L----"'-----'-~--
0 1,894 Y2 1,773 1,894 2,046 2,225
Real GDP Real GDP

Suppose the money market was originally in equilibrium at point A. If the Money Supply
increased from 412 to 457:

Part 1: Which components of Aggregate Expenditures are impacted by the increase in money
supply??
 \
•
Part 2: If the increase • autonomous expenditures
1n • •
as 1nterest rat es "ell
11 from 4°/4 to 2% shifted
the AD curve from ADo to AD1:

a) Calculate the increase in output in the short run:

b) How much inflation resulted from this increase in Aggregate Demand in the short run?

c) Calculate the expenditures multiplier in the Aggregate Demand-Aggregate Supply model:

d) Calculate the increase in output in the long run:

e) How much inflation resulted from the reduction in interest rates from 4% to 2% in the long run?

I
I I
 Part 3: The increase money sup I f .
by: P Y ram 41 2 to 457 increased business investment expenditures

Part 4: The increase in m

oney supply from 412 to 457 increased autonomous expenditures by:

Part 5: Using numbers from the Aggregate Demand-Aggregate Supply model (Panel 4), what is
the new equilibrium output (Y2) in the Aggregate Expenditures (AE) model after the increase in
the money supply from 412 to 457?

Part 6: Calculate the expenditures multiplier from the Aggregate Expenditures (AE) model:

Part 7: Based on the Aggregate Expenditures model, how much inflation resulted from the
increase in Aggregate Expenditures from AE1 to AE2 due to the increase in money supply from
412 to 457?