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Suppose that the real money demand function is

Md/P = 500 + 0.2Y - 1000i. Answer the following 2 questions:  show the impact.

a. Suppose that the economy is at the full-employment level. In that case Y=1000, P=100, and i=0.10. Calculate the real money demand and the nominal money demand. SHOW WORK and discuss.

b. Write down the equilibrium equation that MUST hold in the Asset Market (i.e. the asset market equilibrium condition). Then solve the condition for P (i.e. rewrite the equation so that you solve for P as a function of all the other variables).

c. Now assume that prices and wages in the economy adjust quickly so that all the markets in the economy are always in equilibrium. Suppose that the interest rate on money increases. What is the impact of this shock on P (hint. Use the equation you solved for in part (c)? Explain. What is the impact on Y (full employment level of output)? Explain. What is the impact on r? Explain.

d. Again, assume that prices and wages in the economy adjust quickly so that all the markets in the economy are always in equilibrium. Suppose government expenditure increases. What is the impact of this shock on P (hint. Use the equation you solved for in part (c)? Explain. What is the impact on Y (full employment level of output)? Explain. What is the impact on r?

Microeconomics, Economics

  • Category:- Microeconomics
  • Reference No.:- M9473559

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