Problem 2.1. Consider a consumer who receives an income of Y at the beginning of each month and

spends it evenly throughout the month on consumption. This income is put in a deposit bearing an

annual interest rate of R, with monthly capitalization of interest. In order to spend the earned money, the

consumer must first transfer the money to a free but interest-free checking account. However, each

transfer - regardless of the amount transferred - costs the consumer time and transaction fees in the

total amount of FC (fixed cost).

a) How much money does the consumer keep on average in the checking account? What does this

amount depend on?

b) What is the total cost of keeping money in the account?

c) How many transfers are made by the consumer in a month?

d) Present the money demand function.

e) Which money demand determinants are not considered in this model?

Problem 2.2. Consider an economy described by the following equations:

: =

: = ,

+

=

where nominal money supply in equilibrium equals = 100. In such an economy, the potential output

is 1225.

a) Derive the formula of the aggregate demand function.

b) Determine the level of prices and output in the long-run equilibrium. Show your answer on a chart.

c) By how much GDP and the prices increase in the short run, if the central bank increases the money

supply by 100? Assume that the economy functions in line with the assumptions of the IS-LM model.

d) By how much GDP and the prices increase in the long run, if the central bank increases the money

supply by 100? Assume that the economy functions in line with assumptions of the classic AS-AD

model.

e) What is the difference between points (c) and (d)? Describe what happens in the economy between

the short- and long-run. Plot both cases on the chart.