How would the rate of inflation differ between two countries

Reference no: EM13180367

Consider a country called Hitech where new arrangements for making payments, such as credit cards and ATMs, have been enthusiastically adopted by the population, thereby reducing the proportion of income that is held as real money balances.

a) Assume the money demand equation is given by (M/P)d=kY , where Y denotes aggregate income and k is a constant (exogenous) parameter. Given the context above, what does k represent and how has k changed as a result of the adoption of new payments in Hitech?

b) Assuming market clearing the money market, use the quantity equation to derive an expression that relateds k with the velocity of money. From this expression, has the velocity of money in Hitech increased or decreased as a result of the innovations in payment arrangements?

c) Now suppose there is another country called Lotech which has not seen the innovations in credit cards and ATMs that Hitech has. If the rate of money growth and the growth rate of real GDP were the same in Hitech and Lotech over this period, then how would the rate of inflation differ between the two countries? Carefully justify your answer using the Quantity Theory of Money.

Reference no: EM13180367

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