Q. Assume a country has a money demand function (M/P)d = kY, where k is a constant parameter. The money supply grows by 12% every year also real income grows by 4% every year.

(a) Illustrate what is the average inflation rate?

(b) Elucidate how would inflation be different if real income growth were higher, say 6%? Explain.

(c) Assume, instead of a constant money demand function, the velocity of money in this economy was growing steadily, say by 2% every annum since of financial innovation. Elucidate how would that affect the inflation rate? Explain.