Aggregate Demand Curve

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Aggregate Demand Curve

• In IS-LM model, price level are assumed to be
  fixed. It is time to release it.
• The aggregate demand (AD) curve shows different
  combinations of the price level and the real
  output at which the money and product market are
  both in equilibrium..

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Shifting in Aggregate Demand Curve

• Any factors (except changing in price level) that
  shift IS curve and / or LM curve will create a
  shift in the AD curve.
• For example, change in nominal money supply and
  change in autonomous planned spending, etc.

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Short-Run Aggregate Supply Curve

• The aggregate supply (AS) curve shows the amount
  of output that business firms are willing to
  produce at different price levels
• The shapes of AS curve can be vertical, upward
  sloped and horizontal.
• The effect of changing in real GDP caused by
  shifting AD curve is greatly depended on the
  shapes of AS curve.

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Short-Run Aggregate Supply Curve
(Constant Nominal Wage Rate but Different Price)
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Short-Run Aggregate Supply Curve (Variable
Nominal Wage Rate but Constant Price)
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How the Wage Rate Is Determined?

• The wage rate is determined by the labor demand
  and the labor supply in the labor market.
• The equilibrium real wage rate is the real wage
  rate for the point at which the labor supply and
  demand curves interest, so there is no pressure
  for change.

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Fiscal and Monetary Expansion in the Short and
Long-Run

• Expansionary fiscal and monetary policy will
  shift the AD curve to the right.
• There is an initial but unstable short-run
  equilibrium at point C. (Note price increase
  from p0 to p1 but same nominal wage, W0).
• When workers demand to raise nominal wage so as
  to retrieve previous real wage (i.e. W0/P0), SAS
  curves will shift to the left until long run
  equilibrium, point E3, (i.e. W3/P3 W0/P0) is
  reached.

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Classical Macroeconomics Quantity Theory of
Money
The quantity equation of money MsV PQ
Where Ms money supply V velocity of money
circulation P general price level Q full
employment output
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Classical Macroeconomics Quantity Theory of
Money (Cont)

• V is regarded as constant because it is mainly
  determined by institutional and technological
  factors (such as payment systems, financial
  systems and consumption patterns) which do not
  change easily.
• Q is regarded as constant too because full
  employment output can be be changed quickly.

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Classical Macroeconomics Quantity Theory of
Money (Cont)
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Classical Macroeconomics Self-Correcting
Economy

• The classical economists assumed that the economy
  would not operate away from the long-run
  aggregate supply curve (LAS).
• They claimed that when there are fluctuations in
  full employment level, price level and then real
  money supply will adjust to affect interest rate
  which creates a self-correcting mechanism to
  maintain full employment output.

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The Keynesian Revolution Failure of
Self-Correction

• When investment and autonomous consumption is
  very interest-inelastic under recession period,
  IS curve will be very steep. Although price will
  decrease, real money supply will increase and
  interest rate will decrease during recession,
  there is not self-correction mechanism. Why? It
  is because investment and autonomous consumption
  can not be stimulated by such decreasing in
  interest rate. So, AD curve can not shift back to
  full employment level.

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The Keynesian Revolution Failure of
Self-Correction (Cont)

• When economy is operated under liquidity trap,
  that is demand for money is very
  interest-elastic, the LM curve will be very flat.
  Even there is an increase in real money supply,
  it will be absorbed as idle money balance. As a
  result, interest rate remain constant after
  increase in real money balance. So, investment
  and autonomous consumption can not be stimulated
  by such increasing in real money supply. So, AD
  curve can not shift back to full employment level.

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Classical VS Keynesian Policy Conclusion

• Classical economists were noninterventionists.
  They stressed self-correction mechanism and
  disfavored active monetary and fiscal policies to
  stabilize the economy.
• Keynesian economists were interventionists. They
  disfavored self-correction mechanism and stressed
  active monetary and fiscal policies to stabilize
  the economy.