Question

Refer to the table for Moola below to answer the following questions. What is the equilibrium interest rate in Moola? What is the level of investment at the equilibrium interest rate? Is there either a recessionary output gap (negative GDP gap) or an inflationary output gap (positive GDP gap) at the equilibrium interest rate, and, if either, what is the amount? Given money demand, by how much would the Moola central bank need to change the money supply to close the output gap? What is the expenditure multiplier in Moola?

Money Supply (\()	Money Demand (\))	Interest Rate (%)	Investment at Interest Rate Shown (\()	Potential Real GDP (\))	Actual Real GDP at Interest (Rate Shown) ($)
500 500 500 500 500	800 700 600 500 400	2 3 4 5 6	50 40 30 20 10	350 350 350 350 350	390 370 350 330 310

Short answer

The equilibrium interest rate is 4%.

The investment level at the equilibrium interest rate is $330.

Yes, there is a recessionary output gap at the equilibrium interest rate.

The change in money supply to close the output gap should be $100, so that aggregate money supply becomes $600.

The expenditure multiplier in Moola is 2.

Step-by-step solution

Computing equilibrium interest and investment

The equilibrium interest rate is obtained when money supply equals money demand in the economy. Form the table

Money supply = Money demand = $500.

At a money demand of $500, the corresponding interest rate is 5%. Thus, the equilibrium interest rate will be 5%.

For the equilibrium interest rate of 5%, the corresponding level of investment is $20.

Computing GDP gap

The actual real GDP at the equilibrium interest rate is $330, which is less than the potential GDP, $350 of the economy. Thus, the economy has a negative GDP gap or recessionary output gap, which can be calculated as

Recessionary output gap = $330 - $ 350 = - $20.

expansionary monetary policy and the expenditure multiplier

The economy has a recessionary output gap, so an expansionary monetary policy by the government of Moola will increase the actual real GDP at the equilibrium interest rate and close this gap. Such policy will minimize the gap and decrease the interest rate to a new equilibrium interest rate level.

Thus, the potential real GDP is equal to actual real GDP (closing the recessionary gap) when the money supply rises by $100 to become $600. The new equilibrium interest rate will become 4%, and the investment spending will be $30.

The expenditure multiplier

The expenditure multiplier is given by

$$\begin{gathered} m=\frac{changeinGDP/income}{changeininvestment} \\ =\frac{∆Y}{∆I}=\frac{350-330}{30-20} \\ =2 \end{gathered}$$

Thus, the expenditure multiplier in Moola is 2.