Question
Suppose that an economy has a constant nominal money supply, a constant level of real output Y = 1500, and a constant real interest rate
Suppose that an economy has a constant nominal money supply, a constant level of real output Y = 1500, and a constant real interest rate r = 0.05, and it's expected rate of inflation is 2%, i.e, e = .02. Suppose that the income elasticity of money demand is Y = 0.5 and the interest elasticity of demand i = -0.2. (a) Suppose that Y decreases to 1425, r remains constant at 0.05 and there is no change in the expected rate of inflation. What is the percentage change in the equilibrium price level? (b) Suppose that r increases to 0.06 and Y remains at 1500. Assuming that expected inflation remains at e = .02, what is the percentage change in the equilibrium price level? (c) Suppose that r increases to 0.06. Assuming that e = .02, what would real output have to be for the equilibrium price level to remain at its initial value?
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