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.