Question

Assume that the long-run aggregate supply curve is vertical at Y = 3, 000 while the short-run aggregate supply curve is horizontal at P = 1.0. The aggregate demand curve is Y = 2(M/P) and M = 1, 500. (Hint: draw a graph on this page to help you work through this question)

1) What is the velocity of money in this case?

2) Suppose the aggregate demand function shifts to Y = (1.5)(M/P). What are the short-run values of P and Y?

3) What is the velocity of money in this case?

4) With the new aggregate demand function, once the economy adjusts to long-run equilibrium, what are P and Y?

5) What is the velocity now?

Answer 1

1) Given information,

M = 1500

P = 1

Y = 3000

To find out the velocity of money. We can use the formula,

M*V = P*Y

1500*V= 1*3000

V = 3000/1500

V =2

2) Given information,

Y = 1.5(M/P)

Short -run supply curve,P =1

M = 1500

Therefore, Y = 1.5(1500/1)

Y = 2250

Short-run values of P and Y are 1 and 2250 respectively.

3) In this case velocity of money is 1.5

Y = 1.5 (M/P)

Velocity is 1.5

4) Given information,

Long -run Y =3000

M = 1500

V =1.5

MV = PY

Therefore, P = MV/ Y

= [(1500)(1.5)]/3000

=0.75

P and Y are 0.75 and 3000 respectively.

5) Velocity is same at 1.5