Suppose money demand depends on the nominal rate of interest and income, so that:

Md

P =L(i,Y)

a. Describe briefly why the money demand curve is downward sloping. In your short description refer to the advantages and disadvantages of holding money.

b. Given your understanding of the drivers of money demand, what should happen to the money demand curve if the nominal interest rate reaches a level of zero, that is i = 0? Assume that nominal interest rates can never be negative, which is also referred to as the zero-lower bound of nominal interest rates (ZLB). Again, think about how this affects the advantages and disadvantages of holding money relative to other assets.

c. Discuss the effect of increasing the money supply in the money market under the assumption that the price level is fixed. Discuss and/or show graphically increases in the money supply, both when i>0 and when i=0. You can draw in the same graph.

d. Suppose you have the real interest rate on the vertical axis instead. What would be different in your analysis from the previous part? Would anything change?