What are the main factors that determine aggregate money demand? ...

[formula1]

What are the main factors that determine aggregate money demand?
 
  What will be an ideal response?

Question 2

This question concerns the mechanism of a reserve currency standard. Two countries, X and Y, have two currencies, x and y, fixed to the reserve currency, the U.S. dollar. Suppose the exchange rate between x and the U.S. dollar is 3x per dollar.
 
  Suppose the exchange rate between y and the U.S. dollar is 5y per dollar. Explain (using numbers) the mechanism if the x-y exchange rate was 0.5 x per y.

[k.lashomb]

Answer to Question 1

The three main factors are interest rate, the price level and real national income. A rise in the interest rate causes individuals in the economy to reduce their demand for money. If the price level rises, individual households and firms will spend more money than before. When real national income (GNP) rises the demand for money will also rise.

Answer to Question 2

At this exchange rate, an investor can make an arbitrage profit by selling 100 to the central bank of X (receiving 300 x), then selling your 300 x to the foreign exchange market for 300 x/(0.5 x per y) = 600 y, then buying U.S. dollars in the amount of 120 from the central bank of Y. Thus the foreign exchange market will bid the x-y exchange rate up to 0.6 x per y.

[formula1]

Correct answers!

[k.lashomb]

Great! Please up vote