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

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Presentation on theme: "Short run – changes that occur within 1-2 years Long run – changes that occur AFTER a few years."— Presentation transcript:

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

3 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

4 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)

5 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

6 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

7 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)


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