Final answer:
Nominal income in period 0 is 50000. Aggregate demand in period 1 falls to 25000. Long-run price level, P1, would be 50, assuming velocity and real GDP remain constant.
Step-by-step explanation:
Using the quantity theory of money, we can determine the state of the macroeconomy for different periods. Initially, the formula Money Supply (M) x Velocity (V) = Nominal GDP (P x Y) is given as M0 = 10000, V0 = 5, P0 = 100, and y0 = 500. To calculate the nominal income in period 0, we multiply the values given for M0 and V0.
Nominal Income (NI0) = M0 x V0 = 10000 x 5 = 50000
In period 1, if the money supply falls to 5000, with the other variables remaining constant, the value of aggregate demand (AD) can be calculated as follows:
Aggregate Demand (AD1) = M1 x V0 = 5000 x 5 = 25000
In the short-run, real incomes might fall because with lower aggregate demand, businesses may sell fewer goods and services at existing prices, potentially leading to lower output and income.
According to the quantity theory, the long-run value of the price level, P1, considering velocity and real GDP remain constant, can be calculated by rearranging the equation as P1 = M1 x V0 / Y0. With real GDP (y0) from period 0 taken as a constant value of 500:
Price Level (P1) = M1 x V0 / y0 = 5000 x 5 / 500 = 50