Consider an economy where the following statistics describe the money market. The reserve deposit ratio is res=0.2, the currency-deposit ratio is cu=0.4, the price level is fixed at 1.0, and the monetary base is 60. The real quantity of money demanded is: L(Y, i) = 0.5Y 10i. Where Y is real output and i is the nominal interest rate. Assume that the expected inflation rate is zero so that the nominal interest rate and the real interest rate are equal.

A) If r=0.10, calculate the money multiplier, the money supply, the deposits, the currency, and the reserves? For what value of real output, Y, does a real interest rate of r=0.10 clear the money market? Money Multiplier:______________

Money Supply:_____________

Deposits:_______________ Currency:_____________

Reserves:_________________

Output:______________

B) Now assume that r=0.05. calculate the money multiplier, the money supply, the deposits, the currency, and the reserves? For what value of real output, Y, does a real interest rate of r=0.05 clear the money market? Money Multiplier:______________

Money Supply:_____________

Deposits:_____________ Currency:_____________ __

Reserves:_______________

Output:______________ C) Now assume that when the real interest rate increases, banks have an incentive to lend a greater portion of their deposits, which reduces the reserve-deposit ratio. In particular, suppose that: res = 0.4 2r. Calculate the money multiplier, the money supply and the level of output that clears the money market when r=0.10 and r=0.05. r=0.10 Money Multiplier: ______________

Money Supply:____________

Output:_________________ Show your work below: r=0.05 Money Multiplier: ______________

Money Supply:____________

Output:_________________ D) Based on your answer above, is the LM curve flatter or steeper when the reserve-deposit ratio depends on the real interest rate than when is fixed? Explain your answers in economic terms. Use graphs.