Consider a standard classical economy where money demand is given by (/)=7Y. Suppose that money supply grows at 10% per year and real income grows at 6% per year.

a. What is the average inflation rate? How would your answer change if real income growth were smaller? Briefly explain your answers.

b. Suppose that the velocity of money was falling steadily as a result of financial innovations. What impact would this have on the inflation rate? Briefly explain.