Problem 1. The Cagan Model. The liquidity function is given by L(Y, i) = Y - 40,000i. Output Y is constant and equal to 3200. The nominal interest rate is i. The real interest rate is 4%. (A) Derive the velocity of money V. (B) The central bank keeps the nominal money supply M constant at 1600, and the public expect the money supply to be constant. Find the price level P. [Hint: P = 1.] (C) The central bank suddenly conducts an open market operation: it purchases government bonds. This intervention changes the money supply by 2%. Will M go up or down? Explain and find the new price level.

Problem 1. The Cagan Model. The liquidity function is given by L(Y, i) = Y - 40,000i. Output Y is constant and equal to 3200. The nominal interest rate is i. The real interest rate is 4%. (A) Derive the velocity of money V. (B) The central bank keeps the nominal money supply M constant at 1600, and the public expect the money supply to be constant. Find the price level P. [Hint: P = 1.] (C) The central bank suddenly conducts an open market operation: it purchases government bonds. This intervention changes the money supply by 2%. Will M go up or down? Explain and find the new price level.

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

Problem 1. The Cagan Model. The liquidity function is given by L(Y, i) = Y – 40,000i. Output Y
is constant and equal to 3200. The nominal interest rate is i. The real interest rate is 4%.
-
(A) Derive the velocity of money V.
(B) The central bank keeps the nominal money supply M constant at 1600, and the public expect the
money supply to be constant. Find the price level P. [Hint: P = 1.]
(C) The central bank suddenly conducts an open market operation: it purchases government bonds. This
intervention changes the money supply by 2%. Will M go up or down? Explain and find the new
price level.

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