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Assume that the demand for money function is DmrM r = 400 - 20, where Dis the quantity of money demanded and () is the rate of interest in percentage terms. The supply of money is 200.
(a) What is the equilibrium value of the interest rate? Calculate.
(b) Suppose, because of expansion in the economy, that the demand curve for money becomes Dm = 500 - 20r, but the supply of money remains at 200. If the interest rate is kept as given in section (a), what situation exists in the money market? What is likely to happen to the equilibrium level of the interest rate in the future?
(c) Given the circumstances described in part (b) and assuming that the Bank of Canada was determined to maintain an interest rate target as given in section (a), what change in the quantity of money supply would be required? Be specific.
(d) What type of intervention by The Bank of Canada would be appropriate for the change in the money supply discussed in part (c)? Explain.
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