Q.2 The demand for money in Oz (a closed economy) is given by: Md = P (600 – 200r + Y) where P is the aggregate price le

[answerhappygod]

Q.2 The demand for money in Oz (a closed economy) is given
by:
Md = P (600 – 200r + Y)
where P is the aggregate price level, r is the (nominal) interest
rate in percent and Y is
aggregate income. For this exercise treat Y and P as exogenous
(given) variables.
a. Graph the money demand equation with M on the horizontal axis,
assuming P = 1 and Y =
200. Briefly explain how money demand might vary with changes in P
and Y, as suggested
by the equation above.
b. Assume that the Central Bank sets the money supply at Ms = 600.
Add this to your graph.
What is the equilibrium interest rate? And the equilibrium level of
money?
c. Suppose that the annual inflation rate is 20% and due to the
wise management of fiscal
policy by the government, national income, Y, grows 10% during the
year. What values of P
and Y should you use to estimate the money demand equation next
year? Assuming that
money supply is constant, calculate the new equilibrium level of
interest rates and money and
graph the new money demand equation (along with the money supply
equation).
d. If the Central Bank wants to restore the interest rate to its
original level (that in Part b)
what should be the change in money supply? Briefly explain the
adjustment process; i.e.
why does the change in money supply affect the interest rate?