Suppose you earn and spend $2,400 per month. You receive your paycheck on the first day of the month and must decide how much of it to hold as cash or in a non-interest-earning checking account and how much to deposit in your savings account. The savings account pays 5 percent interest; however, the bank charges you $2 for each withdrawal you make during the month.
(a) What will be your average demand for money over the month?
(b) If the interest rate rose to 10 percent, what would be your average demand for money over the month? Is this change consistent with your expectations about the demand for money?