Question

1. An economy begins in long-run equilibrium, and then a change in government regulations makes holding and using credit cards more desirable.

1. How does this change affect the demand for money?

2. What happens to the velocity of money?

3. If the Fed keeps the money supply constant, what will happen to output and prices in the short run and in the long run?

4. If the goal of the Fed is to stabilize the price level, should the Fed keep the money supply constant in response to this regulatory change? If not, what should it do? Why?

Answer 1

When the government decides holding and using credit cards more desirable the people will keep less cash in their hands and hence there is greater demand for digital currencies than cash in hands this will reduce the demand for money

When the people desired to hold more credit cards than the cash in hands the velocity of money increases as velocity of money is inversely related to the demand for money
The basic equation is MV=PY
Whe Fed decides to keep the money supply constant in the short run we assume that price level is fixed and aggregate supply curve is flat this percentage change in price is zero and the output will remain constant
In the long run prices are flexible and the prices fall over time and the percentage changes in output is zero
If the goal of Fed is to stabilize the price level the Fed should not keep the money supply constant instead Fed should increase the money supply and shift the aggregate demand curve upward .It must increase the aggregate demand to offset the decrease in velocity.