Suppose the money demand function is Md/P = 1000 + 0.2Y - 1000 (r + ?e).(a)Calculate velocity if Y = 2000, r = .06, and ?e = .04.(b)If the money supply (Ms) is 2600, what is the price level?(c)Now suppose the real interest rate rises to 0.11, but Y and Ms are unchanged. What happens to velocity and the price level? So if the nominal interest rate were to rise from 0.10 to 0.15 over the course of a year, with Y remaining at 2000, what would the inflation rate be?
What will be an ideal response?
| (a) | V = PY/M = Y/(M/P). From the money demand function, M/P = 1300. So V = 2000/1300 = 1.54. |
| (b) | P = Ms/(Md/P) = 2600/1300 = 2. |
| (c) | Now Md/P = 1250. So V = 2000/1250 = 1.6. P = Ms/(Md/P) = 2600/1250 = 2.08. The inflation rate |
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