From the equation of exchange, MV = PY, we know that spending growth (M + v ) eq

Question

From the equation of exchange, MV = PY, we know that spending growth (M + v ) equals nominal GDP growth (P + YR) or that. Recall from the chapter that in the long run the inflation rate is found where the AD curve intersects the Solow growth curve (reading off the vertical axis) and the expected inflation rate is found where the short-run aggregate supply curve intersects the Solow growth curve. With these things in mind, assume that the Solow growth rate is 3% and answer parts a through d below. If spending growth equals 10%, what will equal in the long run? What will E pi equal? If spending growth equals 6%, what will pi-equal in the long run? What will E pi equal? If spending growth equals 4%, what will pi-equal in the long run? What will En equal? What can we say about inflation pi and expected inflation E pi in the long run?

Explanation / Answer

a. = 10%-3% = 7% . E = 7%

b. = 6%-3% = 3%. E = 3%

c. = 4% - 3% = 1%. E = 1%.

d. In the long-run, firms expect the inflation rate that actually occurs and in the long run this rate is found where the AD, Solow, and SRAS curves all intersect.

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