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1) Suppose that demand for money in the country of Monia depends on the interest rate r

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1) Suppose that demand for money in the country of Monia depends on the interest rate r.

Money demand in Monia is represented by the function M D = 1400 + (10/r). The current

supply of money in Monia is M=1500. Note that the interest rate, r , is written as a

decimal (e.g., an interest rate of 1% would be written as 0.01 in the equation). Assume

that price level (P) is equal to 1.

a) Suppose the money market in Monia is in equilibrium. What is the initial equilibrium

level of interest rate in Monia? Hint: set money demand equal to money supply and

solve

b) Suppose that the central bank in Monia determines that the equilibrium interest rate

should be equal to 5%. What is the level of the money supply required for the interest rate

to be at this level? Assume that the demand for money remains unchanged. (5 Points).

Hint: set r=0.05 and solve for money demand.

c) Suppose that in Monia the level of prices is 30 and real income is 300. Calculate the

velocity in Monia when the interest rate is equal to 10%. Assume that the money market

is in equilibrium for each calculation. Hint: use interest rate to solve for money supply

and derive velocity. Use the velocity of money equation.