2.00 1.75 MS 1.50 O 1.25 Money Demand VALUE OF MONEY 1.00 0.75 MS 2 0.50 0.25 2 3 5 6 7 8 QUANTITY OF MONEY (Billions of dollars) According to your graph, the equilibrium value of money is , therefore the equilibrium price level is Now, suppose that the Fed increases the money supply from the initial level of $3.5 billion to $7 billion. In order to increase the money supply, the Fed can use open market operations to the public. Use the purple line (diamond symbol) to plot the new money supply (MS2 ). Immediately after the Fed changes the money supply from its initial equilibrium level, the quantity of money supplied is than the quantity of money demanded at the initial equilibrium. This expansion in the money supply will people's demand for goods and services. In the long run, since the economy's ability to produce goods and services has not changed, the prices of goods and services will and the value of money will3. The classical dichotomy and the neutrality of money The classical dichotomy is the separation of real and nominal variables. The following questions test your understanding of this distinction. Hannah divides all of her income between spending on paperbacks and Americanos. In 2012, she earned an hourly wage of $28.00, the price of a paperback was $7.00, and the price of a Americano was $4.00. Which of the following give the real value of a variable? Check all that apply. The price of a paperback is $7.00 in 2012. The price of a paperback is 1.75 Americanos in 2012. Hannah's wage is $28.00 per hour in 2012. Which of the following give the nominal value of a variable? Check all that apply. The price of a Americano is 0.57 paperbacks in 2012. The price of a Americano is $4.00 in 2012. Hannah's wage is 4 paperbacks per hour in 2012. Suppose that the Fed sharply increases the money supply between 2012 and 2017. In 2017, Hannah's wage has risen to $56.00 per hour. The price of a paperback is $14.00 and the price of a Americano is $8.00. In 2017, the relative price of a paperback is V . Between 2012 and 2017, the nominal value of Hannah's wage V , and the real value of her wage V . Monetary neutrality is the proposition that a change in the money supply V nominal variables and V real variables. 2. Money supply, money demand, and adjustment to monetary equilibrium The following table gives the quantity of money demanded at various price levels (P), the money demand schedule. In the following table, ll in the column labeled Value of Money. Quantity of Money Demanded Price Level (P) Value of Money (1 / P) (Billions of dollars) 0.80 1.25 V 1.5 1.00 1.00 V 2.0 1.33 0.75 V 3.5 2.00 0.50 V 7.0 Now consider the relationship between the quantity of money that people demand and the price level. The lower the price level, the more V money required to complete transactions, and the more V money people will want to hold in the form of currency or demand deposits. Assume that the Federal Reserve initially fixes the quantity of money supplied at $3.5 billion. Use the orange line (square symbol) to plot the initial money supply (MS 1 ) set by the Fed. Then, referring to the previous table, use the blue connected points (circle symbol) to graph the money demand curve