Money, Prices, Inflation & Interest Rates in the Long Run Use the Classical model in Chapter 5 to answer this one. An

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Money, Prices, Inflation & Interest Rates in the Long
Run

Use the Classical model in Chapter 5 to answer this one.

An economy has the following money demand function: 𝐿𝐿= .1𝑌𝑌 √𝑖𝑖⁄
.

a. Derive an expression for velocity. What does it depend
upon?

b. Calculate velocity if the nominal interest rate is 𝑖𝑖 = 4
percent.

c. If income is 𝑌𝑌= 1000 and the money supply is 𝑀𝑀= 1500, what is
the price level, 𝑃𝑃?
d. Suppose the government announces the appointment of a new
Chairman of the Fed. She has a
reputation for being soft on inflation, so the expected inflation
rate immediately increases by 5
percent. What is the new nominal interest rate?
e. Calculate the new velocity.
f. Assuming that neither real GDP nor the money supply have
changed, what is the new price level?
Explain the change in 𝑃𝑃.
g. If the Fed wanted to keep the price level constant after the
announcement, at what level should it
set the money supply, 𝑀𝑀?