(a)Consider an economy in a long-run equilibrium with Y = 40 and PIE = 3. A demand shock in period one causes output to rise to 45 and inflation rises to 4. Then, the updating of expected inflation to equal 4 causes output in period two to decline to 43.85, and inflation to rise to 4.77. Assuming no further shocks, calculate the values of output and inflation for period three. (5 marks)

(b)Assume that in a given time frame, the value of transactions in current dollars is $14 trillion and the money stock amounts to $400 billion.

i) Calculate the transactions velocity of money? (2 marks)

ii) What does the transaction variable (T) include? (2 marks)

(C) Using the IS-LM model determine the affect does the following have on the shape of the aggregate demand curve:

i) A high interest elasticity of investment (3 marks)

ii) A low interest elasticity of money demands (3 marks)