Consider an economy that produce and consume only one product. The price of two physical units of this product is equal to $5 billion in the long-run equilibrium.

1.

2. 3.

Draw a typical monetary market diagram where the real value of currency and the level of price are the two vertical axes and the quantity of money is in the horizontal axis.

Interpret the slopes of MD and MS curves.

Suppose the MD = 200 P + 60, what is the money supply of equilibrium?

Consider that the government increases the money supply by printing more money to end an ongoing budget deficit of to $140 billion. Economists agree that an increase in money supply causes inflation. This can be explained in two ways:

4. Quantitative explanation:

a. What is the real value of $1 before money injection?

b. Using the MD equation in (3), find the real value of $1 after money injection.

c. What is the equivalent inflation rate?

5. Qualitative explanation:

a. How does an increase in MS affect the interest rate r? Explain (you can use a

graph.)