Draw the supply/demand for money diagram to show the following effects: 

A. Assume that the economy records an increase in real GDP. Show the effect of this on money demand. Assuming the central bank does not respond, how will this affect the value of money and the equilibrium price level?

B. Now assume that the central bank does respond to this change in order to keep the price level at the original level. How should they go about it? Show their action on a diagram.

C. Returning to part a, assume that together with the increase in GDP there is a decrease in the velocity of money. First explain what exactly this means, and then describe how your answers in parts a. and b. change, using a new diagram.

D. Now consider a new situation (i.e. disregard the changes in the previous parts). Assume that the central bank increases the amount of money in the economy, but there is no change in GDP nor money velocity. Show the situation in a new diagram and describe your reasoning.

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A When the economy experiences an increase in real GDP this will lead to an increased demand for money The higher level of economic activity and transactions requires more money to facilitate those tr... View the full answer