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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) (30 marks) Find the price level P in this economy.
(b) (5 marks) 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.

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