Question 1: Money and Infation (20 Marks) Suppose that a typical country’s money demand function Md is given by: Md = PY 0:75 where P stands for the…

 Question 1: Money and Infation (20 Marks)

Suppose that a typical country’s money demand function Md is given by:

Md = PY 0:75

where P stands for the price level and Y for output.

(a) What is the income elasticity of money demand?

(b) If in the current year the price level is P = 1, how much do the money supply Ms and output Y need

to be for the velocity V to be equal to 1:5?

(c) How much is the predicted ination rate if the money supply has been growing at 2:0% per year,

while real output has been growing at 4:0% per year?

(d) Are the following money demand functions compatible with the Quantity Theory of Money? Why?

i) Md = P

????

Y 3 + Y 2 + Y

;

ii) Md =

p

5Y ;

iii) Md = 1

4Y ???? 2i (i stands for the nominal interest rate):

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