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Consider a version of the economic model with the associated assumptions of Chapter 6, in which the money growth rate is a random variable.


 Consider a version of the economic model with the associated assumptions of Chapter 6, in which the money growth rate is a random variable. Let the probability be 4/5 that zt = 1 and the probability be 1/5 that zt = 2. The realization of the monetary policy (the realized value of zt ) is kept secret from the young until all purchases have occurred - that is, people do not learn Mt until period t is over. Prices are only thing directly observable by the young. Let ????(????????????)=5+0.2???????????? in island i at time t. 

  1. (a) Solve for ???????????? using the market clearing condition. (5 marks) 
  2. (b) Can the worker make use of this price level as an indicator of the unknown monetary policy? (5 marks) 
  3. (c) How can the workers make use of the price obtained in part a to decide on their work decision? (5 marks) 


Show all your steps and explain your answers to avoid grade penalty. 

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