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Consider a hypothetical economy with the following properties at the beginning of Year 1: o The economy has a total money supply of $1 millon.

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Consider a hypothetical economy with the following properties at the beginning of Year 1: o The economy has a total money supply of $1 millon. o The general public holds $200,000 worth of government bonds. I The minimum reserve requirement for the banking sector is 25%. During Year 1 the government conducts open-market operations and buys back $100,000 worth of government bonds from the public. The households who receive money from selling the government bonds deposit all the money into banks as demand deposits. No banks in the economy keep excess reserve. During Year 2 the government further buys back the other $100,000 worth of government bonds from the public. The households who receive money from selling the government bonds continue to deposit all the money into banks as demand deposits. It also remains to be the case that no banks in the economy keep excess reserve. 1. Find the amount of money supply at the end of Year 1 (the beginning of Year 2). (8 points) 2. Find the amount of money supply at the end of Year 2. (8 points] 3. Calculate the rate of increase in money supply from Year 1 to Year 2. (6 points) 4. State the quantity equation of money. Use the equation to explain how the quantity theory of money determines the ination rate from Year 1 to Year 2. (18 points)

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