A country's central bank is engaging in monetary contraction, with M going from M0=40 to M1=20. Its economy is as follows.
Goods:
slc = 3
MPC = 0.7
G = 10
T = 9
Before the policy, the goods
Financial:
I = 18-200r
Before the policy, the loans market equilibrium is at r = 4.25% and I = 9.5
Money:
M0 = 40
P0 = 2
M/P = 0.02 / (r - Y/5000)^2
and finally, Labor:
w = MPL = 0.5 * 4.5 * 16^0.5 / L^0.5
w = EP / P0 * L^0.5
Where workers currently expect the price level of EP=2.
How does the monetary contraction directly and immediately affect the goods market?
There are four endogenous variables that adjust in response to shock/policy: Y, I, r, P. The policy variable of interest is M. Therefore, let's approach our solution by first recognizing that all other letters are just constants and plug them in.
For example: Y = 2 + 0.5(Y-6)+7+I becomes Y = 12 + 2*I
First, express the goods market as expenditure being a linear function of investment I of the form:
Y = a + b*I
where a and b are parameters (numbers).
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