Neutrality of money is the idea that a change in the stock of
money affects only nominal variables in the economy such as prices,
wages, and exchange rates, with no effect on real variables, like
employment, real GDP, and real consumption.
Aus <https://en.wikipedia.org/wiki/Neutrality_of_money>
In economics, nominal value is measured in terms of money,
whereas real value is measured against goods or services. A real value is
one which has been adjusted for inflation, enabling comparison of
quantities as if the prices of goods had not changed on average.
Aus
<https://en.wikipedia.org/wiki/Real_versus_nominal_value_(economics)
#Commodity_bundles,_price_indices_and_inflation>
The classical dichotomy is the idea, attributed to classical and
pre-Keynesian economics, that real and nominal variables can be
analyzed separately. To be precise, an economy exhibits the classical
dichotomy if real variables such as output and real interest rates can be
completely analyzed without considering what is happening to their
nominal counterparts, the money value of output and the interest rate.
Aus <https://en.wikipedia.org/wiki/Classical_dichotomy>
New classical model
LRAS
1. Why is the LRAS curve vertical?

Because in the long run, an economy's production of goods and
services depends on the quantities of labor, capital and natural
resources, and on the available technology used to turn these
inputs into outputs. The average price level does not affect any of
these long-run determinants of real GDP.

It is consistent with the classical macroeconomic assumption that
real variables do not depend on nominal variables, since it implies
that the quantity of output (real variable) is independent of the
price level (nomial variable)
2. What will shift the LRAS curve? (changes in four determinants)
This is essentially an outward shift of the PPC curve
 Labor: immigration, birth rate, natural rate of unemployment
 Capital: investment
 Natural resources: discovery of new resources, change in weather
patterns, land reclamation
 Technological knowledge
SRAS
1. We can think of the SRAS curve as similar to the LRAS curve but
made upward sloping by the presence of misperceptions, sticky
wages and sticky prices.
2. Short-run fluctuations in output and price level should be view as
deviations from the continuing long-run trends.
3. Why is the SRAS curve upward sloping?
 The misperceptions theory: A lower price level causes
misperceptions about relative prices, and these misperceptions
induce suppliers to respond to the lower price level by decreasing
the quantity of goods and services supplied.
(When suppliers see the prices of their products fall, they may
mistakenly believe that their relative prices have fallen.)
 The sticky wage theory: Nominal wages do not adjust immediately
to the price level due to long-term contracts that fix nominal
wages, for as long as three years and social norms and the notion
of fairness. A lower price level makes employment and production
less profitable, which induces firms to reduce the quantity of
goods and services supplied.
 The sticky price theory: The prices of some goods and services
adjust sluggishly in response to changing economic conditions due
to menu costs. An unexpectedly low price level leaves some firms
with higher-than-desired prices, which depresses their sales and
leads them to cut back production.
Menu costs include the costs of printing and distributing catalogs and
the time required to change price tags.
All three theories suggest that output deviates from its natural rate
when the price level deviates from the price level that people expected.
Eventually, people adjust their expectations, misperceptions are
corrected, nominal wages adjust, and prices become unstuck. In other
words, the expected and actual price levels are equal in the long run.
4. What will shift the SRAS curve?




A change in wage rate
A change in the costs of raw material
A change in the price of imports
A change in government indirect taxes or subsidies
Q2
The new classical LRAS curve is vertical, which suggests that in the long
run, the quantity of output (a real variable) does not depend on the
average price level (a nominal variable). This is based on the belief that
in the long run, an economy's production of goods and services is
determined by the quantities of labor, capital and natural resources and
on the available technology used to turn these factors of production into
outputs. Since the price level does not affect any of these long-run
determinants of real GDP, LRAS is perfectly inelastic. Moreover, it is
consistent with the classical macroeconomic assumption that real
variables are independent of nominal variables.
In contrast, the Keynesian AS shows three possible phases and does not
distinguish between the short run and the long run. In the first phase,
the AS curve will be perfectly elastic at low levels of economic activity
due to the existence of spare capacity in the economy. Therefore, an
increase in AD will cause real GDP and employment to rise, with no
inflation. In the second phase, the AS curve is upward sloping, which
corresponds to the SRAS curve in the new classical model. The shape of
the curve can be explained by the presence of misperceptions, sticky
wages and sticky prices. A higher average price level is likely to make
suppliers mistakenly believe that the relative prices of their products
have increased, thereby responding to the higher average price level by
increasing the quantities supplied. Besides, since nominal wages are
slow to adjust, a higher price level means that production becomes more
profitable, inducing suppliers to produce more. In addition, the prices of
some goods and services also adjust sluggishly in response to changing
economic conditions as a result of menu costs, which include the costs
of printing new catalogs and the time required to change price tags.
Firms that face high menu costs are likely to prefer not to raise prices
immediately following a surge in the average price level. This makes
their goods more attractive, as they are now relatively cheaper. Thus,
the demand for their goods increases, encouraging the firms to produce
more. In the third phase, the AS curve is vertical, which corresponds to
the LRAS of the new classical economists. This is when the economy
reaches its full employment of output. A rightward shift of the AD curve
will only result in inflation, with no economic growth.
Q3
Potential economic growth is also known as trend growth and is the long
term non-inflationary increase in GDP caused by an increase in a
country‘s productive capacity. In other words, it represents an increase
in potential output, which is driven by improvements in the long run
aggregate supply. Therefore, factors resulting in shifts of the LRAS curve
will affect potential economic growth, and these include the quality and
quantity of labor, capital and natural resources, and the degree of
technological developments.