A Bigg Boss 16 12th October onli x Learn: ECON 2201 MIDTERM 1 X Homework Help - Q&A from Or X midterm_question_and_solution X ECON 2201 : Intermediate Mac X + C @ File | /Users/deepaksharma/Downloads/midterm_question_and_solution.pdf To W Q APES Chapter 12... G nekton definition -... M Gmail YouTube Maps 5 Halftime Forex Factory Netflix f Facebook E midterm_question_and_solution.pdf 3 / 6 100% OPEN ANSWER QUESTIONS (20pts each) 1. (a) What is the classical dichotomy? (b) Give a mathematical formulation of this theory and derive its implications for monetary policy. (a) The classical dichotomy implies that the real economy reaches its equi- librium independently of the nominal side of the economy. The equilib rium is completely insulated from any change to the nominal side of the economy. (b) The theory is most simply stated with the following equation MV = PY (note to grader: the "bar" on Y may be omitted, but the bar on V is required) which represents an accounting identity (i.e. a necessarily true statement) augmented with the hypothesis that the velocity of circula- tion of money is constant. From this theory one sees that AM = AP and therefore this theory predicts that monetary policy can only produce inflation. 2. (a) What are the options to finance an increase in government expenditure (AG > 0) in the classical model? (b) And what are their respective effects on private consumption and on the economy's savings? (a) In the classical model we have studied in class, a government can finance their expenditure G only in two ways: by increasing taxes, or by issuing more debt. (b) The first option causes private consumption to decrease by an amount equal to -MPC x AT = -MPC x AG and aggregate savings decrease by AS = AY -AC-AG = 0+MPC x AG- AG. The second option does not affect consumption directly but it still decreases aggregate savings by AS = -AG. In both cases the amount of saving in the economy decreases, but this effect is more intense when government spending is financed by debt