Suppose the real money demand function is:Md/P= 1500 + 0.2Y- 10,000 (r +e).

Assume M = 3600, P = 2.0, e = 0.01, and Y = 5000.

Note: we are holding P and Y constant in this problem until we get to case #2 below.

a)(5)What is the market clearing real interest rate?

r =

b)(10)Show your results on a real money supply, real money demand diagram and label this initial equilibrium point as point A. Be sure to label your graph completely! Correctly drawn and completely labeled diagram is worth 10 points total. Be sure to put relevant shift variables in parentheses next to the appropriate function.

Case #1

c)(5points) Suppose Janet Yellen and the Fed were successful in their campaign to raise inflationary expectations to 4% (.04). Use the Fisher equation to support your argument.

d)(5 points) Solve for the real interest rate that clears the money market given the change in inflationary expectations. Please show work and Label this new point as point B on your diagram above.r =

e)(10 points) Explain how this strategy of raising inflationary expectations is supposed to stimulate output.Recall that output is equal to C + I + G! Be very specific. Hint: The price of current consumption in terms of future consumption and the user cost of capital most definitely need to be in your response.