Question

Explaining short-run economic fluctuations

Answer 1

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 NOMINAL variable, will cause the price level, a NOMINAL variable, to increase but will have no long-run effect on the quantity of goods and services the economy can produce, a REAL variable. The distinction between real variables and nominal variables is known as CLASSICAL DICHOTOMY.

The vertical axis of the aggregate demand and aggregate supply model measures the overall PRICE LEVEL. The aggregate SUPPLY Curve shows the quantity of goods and services that firms produce and sell at each price level.

Explanation:

A nominal variable is a type of variable that is used to name, label or categorize particular attributes that are being measured.

It takes qualitative values representing different categories, and there is no intrinsic ordering of these categories.

The difference between nominal and real variables is the inflation rate. For example, the difference between the nominal interest rate and the real interest rate is the inflation rate.

Real variables are those where the effects of prices and/or inflation have been taken out.  Nominal variables are those where the effects of inflation have not been controlled for. As a result, nominal but not real variables are affected by changes in prices and inflation

The classical dichotomy refers to the idea that real variables, like output and employment, are independent of monetary variables. In this view, the primary function of money is to act as a lubricant for the efficient production and exchange of commodities

The general price level is a hypothetical measure of overall prices for some set of goods and services in an economy or monetary union during a given interval  normalized relative to some base set.

Aggregate supply, or AS, refers to the total quantity of output in other words, real GDP firms will produce and sell. The aggregate supply curve shows the total quantity of output real GDP that firms will produce and sell at each price level.  The graph shows an upward sloping aggregate supply curve.