The following four equations relate to an economy. Use them to answer the questions that follow. Product Market: y= c(y-c) + i(r) + g Money Market: ṁ= i(r) + k(y) Production function: y= y(N; Ǩ) Labour Market: p,f(N)= P­­e * g(N)= P(p) * g(N) Draw the classical model in the price income (P-Y) space graph and explain what happens when the nominal money supply rises. Assuming a complete and correct adjustment (P­­e to P), derive the effect of fiscal policy increase in the government expenditure and explain the differences of the fiscal policy when p=0 and when P=1

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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.