The following set of equations describe an economy: C = 14,400 + 0.5 (Y – T) – 40,000r Ip = 8,000 – 20,000r G = 7,800 NX = 1,800 T= 8,000 %3D Y* = 40,000 Suppose that the real interest rate (r) is 10%. Is the economy in long run equilibrium? If not, what real interest rate should central bank set to restore the economy back to the long run equilibrium? And what methods can central bank use to adjust the interest rate? (Round your answer to 2 decimal

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Inflation and Purchasing Power Theory

In economic terms, Inflation refers to the increase in the costs of various commodities which are used in daily lifestyle like food, clothes, transport, etc. over a specific time. It may lead to a fall in the purchasing power of the people and also affects the exchange rate of the currency because of the price increase. As the purchasing power falls the unit of the currency in the economy falls. When the prices of the commodities are decreased, then the purchasing power of the consumers will rise, then it will lead to deflation and changes the currency of the base economy to that of the foreign economy which will lead to change in exchange rates.