This is a numerical application of the Lucas model presented in Module 4.

People live on two islands and they are equally distributed regardless of their island of birth. The total population on both islands is 700. There is an initial stock of fiat money of $600.

There are equal probabilities that a person is on either island. Assume that labor supply does not depend on price observed: l(pti) = 3

Answer the following questions:

a) What is the money market clearing condition for each island?

b) What is the equilibrium price on each island in period 1?

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