You Have Been Told That the Money Demand Function in the United

question 48

Essay

You have been told that the money demand function in the United States has been unstable since the late 1970. To investigate this problem, you collect data on the real money supply (m=M/P; where M is M₁ and P is the GDP deflator), (real)gross domestic product (GDP)and the nominal interest rate (R). Next you consider estimating the demand for money using the following alternative functional forms:
(i)m = β₀ + β₁ × GDP + β₂ x R+ u
(ii)m = β₀ × $G D P ^ { \beta 1 }$ x ${ R } ^ { \beta 2 }$ × e^u
(iii)m = β₀ × $G D P ^ { \beta 1 }$ x $1 + R ^ { \beta _ { 2 } }$ × e^u
Give an interpretation for β₁ and β₂ in each case. How would you calculate the income elasticity in case (i)?

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