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

Answer 1

The correct answers are:

Money Supply - Nominal Variable

Price Level - Nominal Variable

Quantity of Goods - Real Variable

Separation of real variables and nominal variables - Classical Dichotomy

Step-by-step explanation:

The statement in the question is the basis of the quantity theory of money.

The Classical Dichotomy in Economics tells us that real variables (such as GDP and the real interest rate) can be analyzed without taking into account nominal variables (such as the money supply, and the nominal interest rate).

And the quantity theory of money simply tells us the following:

Money Supply * Velocity = Price Level * Real GDP

Velocity is constant, and Real GDP, a real variable, does not depend on the nominal variables of the equation (Money Supply, Velocity, and Price Level), but on the factors of production (labor, capital, and land), therefore, the equation can be written as:

Money Supply = Price Level.

In other words, the price level, or inflation, in the long run, a nominal variable, depends on another nominal variable, the money supply, while real GDP, a real variable, is fixed by real factors of production. This is an example of the classical dichotomy.