Question
Using the attached hypothetical demand curve, answer the following questions:
- What is the quantity of money demanded when the interest rate is 6%?
- What is the quantity of money demanded when the interest rate is 8%?
- Choose the statement that best explains the relationship between the quantity of money demanded and the interest rate on bonds.
A) If the interest rates increase, the quantity of money demanded decreases.
B) If the interest rates increase, money demand falls.
C) If the interest rates increase, money demand increases.
D) If the interest rates increase, the quantity of money demanded increases.
Answer 1) & 2)
When the interest rate is 6%, the demand for money is $40 billion, and when the interest rate climbs to 8%, the money nosedives to $20 billion.
Answer 3):
The correct choice is B)
Explanation:
The relationship between interest rate and money demand is very simple. The higher the rate, the higher the cost of capital. The higher the cost of capital, the lower the Return On Investment. Because businesses are structured to thrive on more profit or returns, business owners, generally will gun for more money when there is a lower interest rate thus creating a surge in demand.
Kindly note that the analysis is based the assumption that all other factors remain constant.
Cheers!
