Use the classical model and the quantity theory of money to predict how each of

Question

Use the classical model and the quantity theory of money to predict how each of the
following shocks would affect the real wage rate (W/P), the real interest rate (r), real
aggregate income (Y), and the price of goods and services (P) in a closed economy in the
long run, all else equal. For each shock, be sure to clearly state a prediction for all four
variables, illustrate your predictions with the relevant diagrams, and explain your
predictions intuitively in words.
a. A increase in the size of the domestic capital supply
b. An increase in the income velocity of money

Explanation / Answer

Wage rate interest rate price of goods increases for increase in domestic capital supply

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