Question 1Money demand in an Economy in which no interest is paid on money is...= XXXXXXXXXX2Y...

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Question 1Money demand in an Economy in which no interest is paid on money is...= XXXXXXXXXX2Y -1000ia. You know that P = 100, Y = 1000, and i = 0.10 Find real money demand, nominal money demand, and velocity.b. The price level doubles from P = 100 to P = 200. Find real money demand, nominal money demand, and velocity.c. Starting from the values in (a), determine how velocity is affected by an increase in real income (Y), an increase in the nominal interest rate, and an increase in the price level.Question 2The following equations describe a Keynesian model of the economy: Cd = XXXXXXXXXX(Y - T) - 100rId = XXXXXXXXXXr L = 0.5Y - 200ipe = 0.05, G = T = 200, = 1850M = 3560(note: remember the Fisher Equation)a.Find the full-employment equilibrium values of the real interest rate, consumption, investment, and the price level. This will be at the intersection of IS and LM.b.Suppose that government purchases rise to 225, with no change in taxes, starting from the equilibrium in part (a). What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and the price level?Question 3Desired consumption is Cd = XXXXXXXXXXY - 100,000 r - G, and desired investment is Id = XXXXXXXXXX,000r. Real money demand is Md/P = Y – 6,000i.Other variables are pe = 0.03, G = 500, Y ”constant”= 1000 and M = 2,100.a.Find the equilibrium values of the real interest rate, consumption, investment, and the price level.Suppose government purchases decline to 400. What happens to the variables listed in part (a)?Suppose government purchases rise to 600. What happens to the variables listed in part (a)? What feature in this example leads to the result that you don't need to know the amount of taxes collected by the government to find the equilibrium?Question 4Suppose you divide your life into two periods working age and retirement age. When you work, you earn labour income Y; when retired, you earn no labour income, but must live off your savings and the interest it earns. You save the amount S while working, earning interest at rate r, so you have (1 + r)S to live on when retired. Because you don't need to consume as much when retired, you want to set consumption when working twice as high as consumption when retired.a. Suppose you earn $1 million over your working life and the real interest rate for retirement saving is 50%. How much will you save and how much will you consume in each part of your life?b. Suppose your current income went up to $2 million when working. Now what will you save and how much will you consume each period?c. Suppose a social security system will pay you 25% of your working income when you are retired. Now (with Y = $1 million, as in part a) how much will you save and how much will you consume each period?d. Suppose the interest rate rises (starting from the situation in part a). Will you save more or less?

David · Accepted Answer

Question 1 
Money demand in an Economy in which no interest is paid on money is... 
= 500 + 0.2Y -1000i 
a. You know that P = 100, Y = 1000, and i = 0.10 Find real money demand, 
nominal money demand, and velocity.  
Answer: 
Real money demand: (Md/P) = 500 + 0.2Y -1000i 
Real money demand (Md/P) = 500+0.2*1000-1000*0.10 = 600 
Nominal money demand (Md) = real money demand*P = 600*100 = $60000 
From quantity theory of money, velocity (V) = (PY/M) = (100*1000)/60000 =  
1.66667 
b. The price level doubles from P = 100 to P = 200. Find real money demand, 
nominal money demand, and velocity.  
Answer: 
Real money demand (Md/P) = 500+0.2*1000-1000*0.10 = 600 
Nominal money demand (Md) = real money demand* new Price = 600*200 = 
$120000 
Velocity (V) = (PY/M) = (200*1000)/120000 = 1.66667
c. Starting from the values in (a), determine how velocity is affected by an 
increase in real income (Y), an increase in the nominal interest rate, and an 
increase in the price level. 
Answer: 
From quantity theory of money, velocity (V) = (PY/M) ………. (1) 
This implies increase in real income (Y) cause velocity to increase.  
Suppose ‘i’ rises from 0.10 to 0.20.  In that case, 
Real money demand = = 500+0.2*1000-1000*0.20 = 500 
And nominal money demand (M) = real money demand* price level = 500*100 = 
$50000 
So velocity = (PY/M) = (100*1000)/50000 = 2 
Thus we note that increase in interest rate cause velocity to increase. 
The effect of increase in price level on velocity can be seen from part (b). In part 
(b), we noted that increase in price level has not caused any change in the 
velocity (V). 
So we conclude that with rise in price level, there will be no effect on velocity (V). 
This happens because increase in price level would cause a proportional increase 
in nominal money supply and hence in view of equation (1), the velocity would 
not get affected.
Question 2 
The following equations describe a Keynesian model of the economy: Cd = 500 + 
0.5(Y - T) - 100r 
Id = 350 - 100r L = 0.5Y - 200i 
πe = 0.05, G = T = 200,  Ybar= 1850 
M = 3560 
(note: remember the Fisher Equation) 
a.Find the full-employment equilibrium values of the real interest rate, 
consumption, investment, and the price level. This will be at the intersection of IS 
and LM. 
Answer: 
IS curve: Y = C+ Id +G i.e. 
Y = 500 + 0.5(Y - T) - 100r + 350 - 100r +200 or 
Y = 500 + 0.5(Y-200) -100r + 350-100r + 200 or 
Y = 500 + 0.5Y – 100 -100r + 350 – 100r + 200 or 
0.5Y = 950 – 200r or 
IS curve equation: Y = 1900 – 400r or r = 4.75 – (Y/400) ………….. (1) 
Given full employment output Y = 1850, so full employment value of real interest 
rate r = 4.75 - (1850/400) = 0.125 
With Y = 1850 and r = 0.125, consumption (C) = 500+0.5*(1850-200)-100*0.125 = 
1312.5 and investment (Id) = 350-100*0.125 = 337.5 
LM curve equation: M/P = L 
This implies P = M/L   ……….. (2) 
According to fisher equation, nominal interest rate (i) = real exchange rate (r) + 
expected inflation (πe) 
So L = 0.5Y – 200*(r+0.05) …………………. (3) 
With Y = 1850 and r = 0.125, L = 0.5*1850-200*(0.125+0.05) = $890 
Given M= 3560 and L = 890,

Question 1 Money demand in an Economy in which no interest is paid on money is... = XXXXXXXXXX2Y -1000i a. You know that P = 100, Y = 1000, and i = 0.10 Find real money demand, nominal money demand,...

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