Consider an economy with a constant nominal money supply, a constant level of real output Y = 100, and a constant real interest rate r = 0.10. Suppose that the income elasticity of money demand is 0.5 and the interest elasticity of money demand is -0.1.
a) By what percentage does the equilibrium price level differ from its initial value if output increases to Y = 106 (and r remains at 0.10)?
b) By what percentage does the equilibrium price level differ from its initial value if the real interest increase to r = 0.11 (and Y remains at 100).
c) Suppose that the real interest rate increase to r = 0.11. What would real output have to be for the equilibrium price level to remain at its initial value?