Most economists believe that real economic variables and nominal economic variab

Question

Most economists believe that real economic variables and nominal economic variables behave independently of each other in the long run.

For example, an increase in the money supply, a--------------   variable, will cause the price level, a----------------------   variable, to increase but will have no long-run effect on the quantity of goods and services the economy can produce, a-----------------   variable. The notion that an increase in the quantity of money will impact the price level but not the output level is known as --------------------.

In the short run, however, most economists believe that real and nominal variables are intertwined. Economists use the model of aggregate demand and aggregate supply to examine the economy's short-run fluctuations around the long-run output level. The following graph shows an incomplete short-run aggregate demand (AD) and aggregate supply (AS) diagram—it needs appropriate labels for the axes and curves. You will identify some of the missing labels in the questions that follow.

The vertical axis of the aggregate demand and aggregate supply model measures the overall ---------------- .

The aggregate-----------------------   curve shows the quantity of goods and services that firms produce and sell at each price level.

Explanation / Answer

Increase in money supply, a NOMINAL variable, will cause price level, a NOMINAL variable to increase, but will have no long run effect on quantity of goods and services the economy can produce, a REAL variable. The notion that an increase in the quantity of money will impact the price level but not the output level is known as NEUTRALITY OF MONEY. In the short run, however, most economists believe that real and nominal variables are intertwined. Economists use the model of aggregate demand and aggregate supply to examine the economy's short-run fluctuations around the long-run output level.

The vertical axis of AD and AS measures the overall PRICE LEVEL IN THE ECONOMY.

The aggregate SUPPLY curve shows the quantity of goods and services that firms produce and sell at each price level.

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