Q1. In quantity theory of money model, MV = PY, assume that V is constant, M is growing at 6% per year, Y is growing at 3%.

a. If r = 2, what is i?

b. If the Fed reduces the money growth rate by 2% points per year, what would be effect on i, given r = 2?

c. If the growth rate of Y increases to 5% per year, what would be the effect on inflation? Interest rate?

Q2. The money supply and money demand functions of an economy are as follows:

Money supply: (M/P)^s

Money demand: (M/P)^d =  L (i, Y) = 0.2Y/0.5i

d. What is the velocity of money in this economy?

e. If output is 1000 units, i is 4 percent and money supply M is $1,200, what is the price level P?

f. If money supply increases by 5%, what will be the impact on price level if the output increases by 2% and the interest rate remains constant?

g. If money supply increases by 5%, what will be the impact on price level if the output increases by 2%, interest rate by 1%?