True or False (explain):
1. Imagine an economy where velocity is constant. The money supply is growing by 10% per year, while the growth rate of real GDP is 5% per year. The nominal rate of interest is 8%. The real interest rate must be 4%.
2. Unanticipated deflation redistributes income and wealth from borrowers to lenders.
3. Suppose there are two types of investments, business investments Ib(r), and real estate investments Ir(r). The gov't decides to subsidize business investments (but not real estate investments). If private savings, Sp, is perfectly interest inelastic (i.e. it's unaffected by the real interest rate), then this subsidy will cause both real estate and business investments to increase.
Using the neoclassical model, predict what would happen to: 1) real wage, 2) employment, 3) GDP, 4) the interest rate, 5) investment and 6) the price level. If some things do not change, you must explain why.
1. There is a permanent increase in the nominal supply of money.
2. The Bush administration cuts income taxes
3. The gov't announces that, because of unseasonably cold weather, there has been a decline in consumption. Income has also decreased, due to dislocations in supply. However, consumption has been falling faster than income. True or False: The neoclassical model predicts that interest rates should increase.
1. If we make the assumption that the velocity of money is constant, then the quantity equation becomes a theory of the effects of money, called the quantity theory of money. Because velocity is fixed, a change in the quantity of money (M) must cause a proportionate change in nominal GDP (PY). So the quantity of money determines the money value of the economy's output.
The relationship between velocity, the money supply, the price level, and output is represented by the equation M * V = P * Y where M is the money supply, V is the velocity, P is the price level, and Y is the quantity of output. P * Y, the price level multiplied by the quantity of output, gives the nominal GDP. Furthermore, this equation can be represented as (percent change in the money supply) + (percent change in velocity) = (percent change in the price level) + (percent change in output). Given ...