Consider an economy with a constant nominal money supply, a constant level of real output Y = 100, and a constant real interest rate r = 0.10. Suppose that the income elasticity of money demand is 0.5 and the interest elasticity of money demand is -0.1.
a. By what percentage does the equilibrium price level differ from its initial value if output increases to Y= 106 (and r remains at 0.10)? (Use Eq. 7.11.)
b. By what percentage does the equilibrium price level differ from its initial value if the real interest rate increases to r = 0.11 (and Y remains at 100)?
c. Suppose that the real interest rate increases to r = 0.11. What would real output have to be in order for the equilibrium price level to remain at its initial value?