1.) Suppose that money in the Land of Oz consists of gold coins. The total quantity of money in circulation is 1,000 gold pieces (gp). The only product of the Land of Oz is emeralds, of which 10,000 are produced each year. The price of an emerald is 2gp.
- (a) What is the monetary velocity in the Land of Oz?
- (b) SupposethatmonetarydemandintheLandofOzisgivenbythemoneydemandfunc- tion L (i, Y) = 100 × Y . What is the interest rate in the initial state in the beginning of i the question?
- (c) Now suppose that Oz falls into recession, and emerald production falls to 9,000. As- suming the velocity of money is fixed, what happens to the price level? What is the inflation rate?
- (d) What theory corresponds to our assumption of constant monetary velocity?
- (e) Suppose that emerald production returns to 10,000. Now suppose that the government of Oz mints 100 new coins. Still assuming constant velocity, what happens to prices? What is the rate of inflation?
- (f) Suppose that instead of maintaining constant velocity, the central bank of Oz changed the interest rate to keep the price level unchanged. What would be the new interest rate?
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