1 . Explaining short-run economic fluctuations 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 7 variable, will cause the price level, a V variable, to increase but will have no long-run effect on the quantity of goods and services the economy can produce, a 7 variable. The notion that an increase in the quantity of money will impact the price level but not the output level is known as V . 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 uctuations around the long-run output level. The following graph shows an incomplete short-run aggregate demand (AD) and aggregate supply (AS) diagramit needs appropriate labels for the axes and curves. You will identify some of the missing labels in the questions that follow. AS VERTICAL AXIS AD HORIZONTAL AXISThe horizontal 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.2 . Why the aggregate demand curve slopes downward The following graph shows the aggregate demand (AD) curve in a hypothetical economy. At point A, the price level is 140, and the quantity of output demanded is $300 billion. Moving down along the aggregate demand curve from point A to point B, the price level falls to 120r and the quantity of output demanded rises to $500 billion. \fAs the price level falls, the cost of borrowing money will '7 , causing the quantity of output demanded to V . This phenomenon is known as the '7 effect. Additionally, as the price level falls, the impact on the domestic interest rate will cause the real value of the dollar to V in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore '7 , and the number of foreign products purchased by domestic consumers and rms (imports) will 7 . Net exports will therefore 7 I causing the quantity of domestic output demanded to '7 . This phenomenon is known as the V effect. 3 . Determinants of aggregate demand The following graph shows an increase in aggregate demand (AD) in a hypothetical country. Specifically, aggregate demand shifts to the right from AD1 to AD2, causing the quantity of output demanded to rise at all price levels. For example, at a price level of 140, output is now $400 billion, where previously it was $300 billion.\fThe following table lists several determinants of aggregate demand. Complete the table by indicating the change in each determinant necessary to increase aggregate demand. Change Needed to Increase AD Wealth v Taxes V Expected rate of return on investment 7 Incomes in other countries 7 6 . Determinants of aggregate supply The following graph shows a decrease in short-run aggregate supply (AS) in a hypothetical economy where the currency is the dollar. Specifically, the short-run aggregate supply curve shifts to the left from AS, to AS2, causing the quantity of output supplied at a price level of 100 to fall from $200 billion to $150 billion.\fThe following table lists several determinants of short-run aggregate supply. Fill in the table by indicating the changes in the determinants necessary to decrease short-run aggregate supply. Change Needed to Decrease AS Inflation expectations Tax rates Burdensome regulations