Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while t

Question

Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while the short-run aggregate supply curve is horizontal at P = 1.0. The aggregate demand curve is Y = 2(M/P) and M = 1,500. a. If the economy is initially in long-run equilibrium, what are the values of P and Y? b. What is the velocity of money in this case? c. Suppose because banks start paying interest on checking accounts, the aggregate dcm function shifts to Y = (15)(MP). What are the short-run values of P and d. What is the velocity of money in this case? e. With the new aggregate demand function, once the economy adjusts to long-run equi what are P and Y? f. What is the velocity now? 4. Monetary policy can be either a stabilizing influence on the economy or a source of instability. Give an explanation for both possibilities.

Explanation / Answer

(3)

(a) In long run equilibrium, aggregate demand equals aggregate supply.

3,000 = 2 x (M/P)

1,500 = 1,500 / P

P = 1

Y = 3,000

(b) By quantity theory of money,

M x V = P x Y

1,500 x V = 1 x 3,000

V = 2

(c)

Equation of AD: Y = 1.5 x (M / P) = 1.5 x 1,500 / P

Since short run P = 1,

Y = 1,5 x 1,500 = 2,250

(d)

V = P x Y / M = 1 x 2,250 / 1,500 = 1.5

(e) Equating AD with AS:

3,000 = 1.5 x (1,500 / P)

2,000 = 1,500 / P

P = 0.75

Y = 3,000

(f)

V = P x Y / M = 0.75 x 3,000 / 1,500 = 1.5

Note: First question is answered in full.

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