Consider the 2 Islands Model discussed in Chapter 6. The initial population is 1000 and population grows by 10% every year. The initial stock of money is 200 and money grows by 20% each year. The probability that a person is on Island 1 is 1/3 and the probability that the person is in Island 2 is 2/3. The labour supply function is given by:

l(pⁱ_t) = 4+0.25pⁱ_t, where notations have usual meanings.

(a)Solve for using the market clearing condition.

(b)Can the worker make use of this price level as an indicator of the unknown monetary policy?

(c)How can the workers make use of the price obtained in part a to decide on their work decision?

Additional Information: 16 pictures provided

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