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1Economics 304 Homework-Lesson 8-Money Market EquilibriumCorrect Answers100 points total:Instructions:Please show all work or points will be taken off. Good luck!1.(65pointstotal)Suppose the real money demand function is:Md/P=1500+0.2Y–10,000 (r+e).AssumeM=4000,P=2.0,e=0.01, andY=5000.Note: we are holding P and Y constant in thisproblem until we get to case #2, see below.a)(5points)What is the market clearing real interest rate?Show your results on a real money supply, real money demand diagram and label this initial equilibriumpoint as point A.Be sure to label your graph completely!Correctly drawn and completely labeled diagram is worth 10 points total.Be sure to putrelevantshift variables in parentheses next to the appropriate function.Case #1b)(5points)Suppose Bernanke and the Fed were successful in their campaign to raise inflationaryexpectations to 4% (.04).Why would they want to do this? Use the Fisher equation to support yourargument.c)(5points)Solve for the real interest rate that clears the money market given the change in inflationaryexpectations. Please show work and Label this new point as point B on yourdiagram.d)(10 points)Explain how this strategy of raising inflationary expectations is supposed to stimulateoutput.Recall that output is equal to C + I + G! Be very specific as this question is worth 10 points.Hint:The price of current consumption in terms of future consumptionandthe user cost of capitalmostdefinitely needs to be in your response.Case #2e)(5 points)Let us return to our original conditions.Pleaseredraw the original graphlocating pointA (this is withe=0.01, we are holding expected inflation constant in case #2). We now experience someeconomic growth so that Y = 6000. This is the only change. Resolve for the market clearing real rate ofinterest and label on your diagram as point B. Please show all work.Correctly drawn and completely labeled diagram is worth 10 points total. Be sure to putrelevantshift variables in parentheses next to the appropriate function.f)(5 points)Now explain exactly why the real rate of interest had to change the way it did to clear themoney market.Please be clear with the intuition being sure to refer to the bond market in youranswer.You should begin your response with"At the same real rate of interest, the money market is no longerclearing. In particular money demand ....."you can finish the rest.g)(5 points)Suppose the Fed wanted to keep real interest rates constant at their original level.Supposealso that the money multiplier is 0.8, which is consistent with reality since the Fed began paying interest onreserves beginning in October 2008.What exactly would the Fed have to do to keep real interest ratesconstant at their original level? Be specific with regard to thetypeandquantityof open market operationsthe Fed would need to conduct to be successful in keeping real interest rates constant at their original level.

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