C = 100 + 0.5 · (Y – T)I = 500 – 1000 -rwhere Y is real output and r is the real interest rate. Government purchases and taxes areĞ = 500, Ť= 100.The LM (money market equilibrium) curve isY5iwhere P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplyingM = 8000 units of money, and expected inflation is a = 0.Assume that the long-run equilibrium level of output is Y = 2000. Short-run equilibrium output is initiallyat the same level (Y = 2000).Suddenly, news of a new world-beating super-vaccine raises expected inflation to = 0.05.1. Suppose the government (not the CB) wants to stabilise the shock in the short-run. Explainwhether it should inerease the government deficit (AĞ > AT) or reduce it (AĞ < AŤ), and how itworks.2. Now suppose the government doesn't do anything, and the CB wants to stabilise the shock in theshort-run. Explain whether it should decrease or increase money supply M if it wants to bringoutput Y back to its long-run equilibrium level. What would happen to the nominal and real interestrate in the short-run, if the CB follows this policy?3. Continue to suppose the government doesn't do anything, and the CB wants to stabilise the shockin the short-run but instead of output, the CB wants to bring the nominal interest rate i back toits long-run equilibrium level. Explain whether it should decrease or increase money supply M, andwhat happens to short-run output Y and the real interest rate r if this policy is followed.4. Suppose the CB reduces money supply M. Explain how the economy would shift from its short-runto long-run equilibrium. In particular, what happens to output Y, the real interest rate r, and pricesP during this process?

In economics, the money marketplace equilibrium refers to a situation wherein the demand for money…

Answered: money market equilibrium

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ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

C = 100 + 0.5 · (Y – T)
I = 500 – 1000 -r
where Y is real output and r is the real interest rate. Government purchases and taxes are
Ğ = 500, Ť= 100.
The LM (money market equilibrium) curve is
Y
5i
where P is the price level and i is the nominal interest rate. The Central Bank (CB) is initially supplying
M = 8000 units of money, and expected inflation is a = 0.
Assume that the long-run equilibrium level of output is Y = 2000. Short-run equilibrium output is initially
at the same level (Y = 2000).
Suddenly, news of a new world-beating super-vaccine raises expected inflation to = 0.05.
1. Suppose the government (not the CB) wants to stabilise the shock in the short-run. Explain
whether it should inerease the government deficit (AĞ > AT) or reduce it (AĞ < AŤ), and how it
works.
2. Now suppose the government doesn't do anything, and the CB wants to stabilise the shock in the
short-run. Explain whether it should decrease or increase money supply M if it wants to bring
output Y back to its long-run equilibrium level. What would happen to the nominal and real interest
rate in the short-run, if the CB follows this policy?
3. Continue to suppose the government doesn't do anything, and the CB wants to stabilise the shock
in the short-run but instead of output, the CB wants to bring the nominal interest rate i back to
its long-run equilibrium level. Explain whether it should decrease or increase money supply M, and
what happens to short-run output Y and the real interest rate r if this policy is followed.
4. Suppose the CB reduces money supply M. Explain how the economy would shift from its short-run
to long-run equilibrium. In particular, what happens to output Y, the real interest rate r, and prices
P during this process?

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