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# PS09__Answers_ - EC340 Spring2011 ProblemSet9 1...

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EC 340 Spring 2011 Problem Set 9 1. Suppose that there are two countries in the world (the U.S. and Europe) and that long run money demand in each country is given by the following two equations: ݉݋݊݁ݕ ݀݁݉ܽ݊݀ ܷ. ܵ.: ܲ ௎ௌ ܻ ௎ௌ 3 ݉݋݊݁ݕ ݀݁݉ܽ݊݀ ܧݑݎ݋݌݁: ܲ ܻ 4 Further suppose that real income in the U.S. is 14, real income in Europe is 7, the U.S. money supply is 8 and the European money supply is 3. Use the quantity theory of money combined with purchasing power parity to derive the equilibrium long run exchange rate between the U.S. dollar and European euro. The relevant equation is as follows: ݁ ൌ ܯ ௎ௌ ܯ ݇ ݇ ௎ௌ ܻ ௎ௌ ܻ In the context of the above equation, ݇ ௎ௌ and ݇ . The exchange rate is expressed as dollars per euro. Filling in the remaining numbers: ݁ ൌ 8 3 14 7 ൌ 4 2. Suppose that there is an unexpected one time, permanent reduction in the U.S. money supply.

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