Suppose the economy is characterized by the following equations.

r = 20.2 0.002Y IS curve

M/P = Y 250(r + e) LM curve

M = 19,800 The nominal money supply

e = 0.2 Expected inflation

= 10,000 Full-employment output

a. [4 pts] Write the equation for the aggregate demand (AD) curve.

b. [10 pts] If the economy begins in long-run equilibrium, what are the equilibrium values of the price level (P), output (Y), and the real interest rate (r)? Graph the AD curve and long-run aggregate supply (LRAS) curve together.

c. [8 pts] Suppose that short-run aggregate supply curve (SRAS) is determined, assuming that wages and prices are rigid in the short-run, as in the Keynesian approach. First plot SRAS curve to the graph that you have obtained in part b. Now suppose that the nominal money supply increases to 21,000. Find the equilibrium price and output levels, both for the short-run and long

run. Finally, show how the economy moves from the short-run equilibrium to long-run equilibrium on the graph.

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d. [8 pts] Now instead of having wages and prices rigid in the short-run, suppose that SRAS curve is determined according to the misperceptions theory as follows:

Y = 10,000 + 100(P - Pe)

First add this SRAS curve to the graph that you had obtained in part b. If the expected price level is the price level you found in part b., what happens to the price level, output, and the real interest rate in the short-run if there is an unanticipated increase in the nominal money supply to 24,937.5? Show the short-run equilibrium point on the graph.