Money Demand Problems

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FE 312Q
Prof. Katherine Smith
Fall 2012
Money Demand Problems
Work together but write up your solutions in your own words. Both on problem sets and
exams your explanation is often more critical than getting the write answer. Full credit
will only be given if answer is correct and explained well.
1. In the Baumol-Tobin model, consider the effects of the following events on the
desired real money balances of households?
a. Real income rises by 10 %
b. Interest rates go down by 10%
c. The interest rate and real income rise by 10%?
2. Given the following money demand function
M
c

P
2 PR
a. Using calculus determine the effect of an increase in the interest rate (R)
on the demand for money. Does this make sense? Explain the intuition.
b. Using calculus determine the effect of an increase in the consumption (c)
on the demand for money. Does this make sense? Explain the intuition.
c. Using calculus determine the effect of an increase in (γ/P) on the demand
for money. Does this make sense? Explain the intuition.