Short run – changes that occur within 1-2 years Long run – changes that occur AFTER a few years

Nominal – variables measured in monetary units Ex. Money Supply, Nominal GDP, wages Real – variables measured in physical units (or adjusted for inflation) Ex. Land, Labor, Capital REAL GDP, REAL wages

Changes in the money supply affect nominal variables, but not real variables (in the long run) Ex. If the money supply increases, everyone has more money – but is anyone actually wealthier? “Monetary Neutrality” - Real variables are not affected by nominal changes (in the long run)

Increases in money supply raise the price level Relies on ‘velocity of money’ equation Equation that shows relationship of nominal GDP to the money supply

M*V = P*Y -Where M is the money supply, V is velocity, P is price level, and Y is real GDP (Velocity is how often money changes hands – it remains stable in the short run) -(in the long run) GDP is determined by REAL variables (factors of production), not money supply -SO, when money supply increases, it can only raise the price level -> Quantity Theory of Money

Only applies to LONG-Run changes Real interest rate = nominal interest rate – inflation If inflation increases, then the nominal interest rate must increase to keep real interest rate constant (because in the long run, real variables aren’t affected by nominal changes)