CA Foundation · Business Economics · Money Market
In an economy, money demand is L = 600 − 25r (₹ crore, r in %). Initially the money supply is ₹350 crore. The central bank raises supply to ₹450 crore. By how many percentage points does the equilibrium interest rate change?
The equilibrium rate falls by 4 percentage points. With supply of ₹350 crore the rate is 10%, found from 600 − 25r = 350. With supply of ₹450 crore, 600 − 25r = 450 gives 6%. Greater supply lowers the interest rate.
- AIt rises by 4 percentage points
- BIt falls by 4 percentage pointsCorrect
- CIt falls by 2 percentage points
- DIt falls by 10 percentage points
Explanation
Initially 600 − 25r = 350 gives r = 10%. After the increase, 600 − 25r = 450 gives r = 6%. So the rate falls by 4 points. The rise option has the wrong direction, and a 2-point fall would come from dividing the 100 crore change by 50 instead of 25.
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