Consider a classical long-run economy described by the following equations:
Y = C + I + G
Y = AL K
A= 50
L= 400
K = 100
G= 0
T = 0
C = 1000 + o.7 (Y-T)
I = 4000 - 150r
(M/P) = L (i,Y) =0.6 Y -100i
M= 10000
E = 2
Note that M is money supply, and E is expected infation.
(a) Find the price level P in this economy.
(b) What if people started to think that the central bank will pursue an inflationary policy in the future, such that E rises to 5. Show how this increase in expected inflation impacts the price level today.