Question

In: Economics

In a hypothetical economy desired consumption and desired investment are: C^d = 184 + .6Y-500r   ...

In a hypothetical economy desired consumption and desired investment are:

C^d = 184 + .6Y-500r    and I^d = 200 -500r

Government purchases are 196.

Real money demand is M^d/ P = 0.5Y - 250 ( r + pi^e) where expected inflation, pi^e, is 0.10. The nominal
money supply is 9890.

a. If full employment output is Y bar =1000, what are the general equilibrium values of the real interest rate, price level, consumption and saving?

b.  What is the value of velocity in this economy?

Solutions

Expert Solution

(a)

In goods market equilibrium, Y = Cd + Id + G

1000 = 184 + 0.6 x 1000 - 500r + 200 - 500r + 196

1000 = 184 + 600 + 200 + 196 - 1000r

1000 = 1180 - 1000r

1000r = 180

r = 0.18

C = 184 + 0.6 x 1000 - 500 x 0.18 = 184 + 600 - 90 = 694

(Private) Saving = Y - C = 1000 - 694 = 306

From money market, Md/P = Ms/P

0.5 x 1000 - 250 x (0.18 + 0.1) = 9890/P

500 - 250 x 0.28 = 9890/P

500 - 70 = 9890/P

430 = 9890/P

P = 23

(b)

Velocity = (P x Y) / (Ms) = (23 x 1000) / 9890 = 2.33


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