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Suppose equilibrium in financial markets is given by:

M / P = Y L(i)

(-)

a. derive an expression for Y in terms of i (i.e. Y = ....).

b. suppose the central bank holds the money supply constant. Using your answer to part a, derive dY/di. What is its sign? How does this relate to the slope of the LM curve we derived graphically in class? (Hint: if y= 1 / f(x), then y' = - f' /f(x)2)

c. If the central bank now wants to keep the interest rate constant, instead of the money supply, how does it need to adjust the real money supply as income increases?

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