Suppose the money demand function is given by Md / P = 640 + 0.1 Y - 5000 ( r +

Question

Suppose the money demand function is given by

                                    Md/P = 640 + 0.1Y - 5000 (r + pi^e).

Suppose the central bank changes the nominal money supply depending on income and inflation:

                                       Ms = 1000 + 0.1Y - 4000 pi.

(a) If expected inflation equals actual inflation = 0.03, Y = 1000, and r = 0.02, calculate the price level.

(b) If inflation rises to 0.04 while the other variables remain as in part a, calculate the price level.

(c) If expected inflation rises to 0.04 while the other variables remain as in part a, calculate the price level.

(d) If the real interest rate rises to 0.03 while the other variables remain as in part a, calculate the price level.

Explanation / Answer

a.   

Md/P = 640 + 0.1Y - 5000 (r + pi^e).

= 640+0.1(1000)

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