W2P1 Money Demand

Question 1

What does real money demand depend upon?

Answer 1

Real money demand depends positively on real income Y, negatively
on nominal interest rates i, and positively on transaction costs c so that
L = (Y(+) i(-) c(+)

Question 2

Is the following statement true or false?
“If inflation is positive, simply maintaining the nominal money supply at some constant level amounts to a contractionary monetary policy”

Answer 2

True
When prices are increasing and the nominal money supply stays constant, then the real money supply will decrease as it is M/P

Question 3

Suppose real GDP increases by 1%, and the real demand for money increases by
1.2%. What is the income elasticity of money demand?

Answer 3

The income elasticity of money demand is 1.2 as real GDP increases by
1% and money demand increases by 1.2%

Question 4

Suppose real GDP increases by 1%, nominal interest rates rise by 1%, and real
money demand increases by 0.5%.Given that the income elasticity of money demand is 1.2, what is the interest elasticity of real money demand?

Answer 4

The 1% increase in real GDP would increase real money demand by
1.2%. Since real money demand only rises by 0.5% we know that the
1% increase in the nominal interest rate decreases real money demand
by 0.7%, hence the interest elasticity of real money demand is -0.7.