Suppose the money demand function takes the form:
(M/P)^d=L(i, Y)= Y/(5i)
i= nominal interest rate
(a) If output grows at rate g, what rate will the demand for real balances grow (assuming constant nominal interest rates)?
(b) What is the velocity of money?
(c) If inflation and nominal interest rates are constant, at what rate, if any, will velocity grow?
(d) How will a permanent (once-and-for-all) increase in the level of interest rates affect the level of velocity? How will it affect the subsequent growth rate of velocity?
Money demand at the given rate of interest is defined as the amount of liquidity that individuals want to hold to ease transactions. Individuals demand money for three reasons, transactional, precautionary, and speculative.
Answer and Explanation:
If the output grows at the rate of g, then the demand for the real money balances will grow by the same rate g keeping the nominal rate of interest...
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from Economics 102: MacroeconomicsChapter 11 / Lesson 10