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Use the Baumol-Tobin model to find money demand under the following assumptions. Income is $5000 per month (which can be broken down into 2500 in real income and a price level of 2) paid at the beginning of each month in the form of interest-earning bonds. Bonds earn an interest rate of 3.2% Each time you sell bonds a brokerage cost of $5.00 is incurred.
a. Find optimal money demand
b. How often are bonds sold and how much are sold each time?
c. Assume that all have the same money demand, as above. Suppose the Fed reduces the money supply to $500 per person. Find the new equilibrium interest rate.
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