The Aggregate Demand curve

Macroeconomic Theory I

ECON222

Fall 2017

Macroeconomic Theory I (ECON222) General Equilibrium Fall 2017 1/8

Key Questions

How rapidly does the economy reach general equilibrium?

Can monetary/scal policy stabilize the economy?

How is aggregate demand related to the price level?

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Price adjustment and the self-correcting economy

After an initial shift, P adjusts and shifts the LM curve back to the
general equilibrium

Classical view: prices are exible and the adjustment process is rapid

Keynesian view: sluggish adjustment of prices prevents general

equilibrium from being attained for much longer
,! the labour market may be out of equilibrium for an extended period
,! in the long run we are all dead.

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Stabilization Policy

Unexpected shifts in the IS, LM and the FE curves are the sources of
business cycles

Stabilization policy is the use of scal and monetary policy to oset

the eects of shocks
,! by shifting the position of the IS and LM curves appropriately

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Monetary Neutrality

Monetary neutrality: When a change in M changes P proportionately

but has no eect on real variables

Keynesian view: money is neutral in the long-run but not in the

short-run
,! pure Classical view: money is always neutral

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The aggregate demand curve

The relation between the aggregate quantity of goods demanded

(C d + I d + G ) and the price level, P
,! associated with the shift to general equilibrium as the LM curve shifts

The AD curve slopes downward.

Macroeconomic Theory I (ECON222) General Equilibrium Fall 2017 6/8

 Figure: The Aggregate Demand Curve

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Factors that shift the AD curve

For a constant P:
,! factors that change aggregate demand will cause the AD curve to shift
,! whenever the IS shifts, the AD curve shifts
,! whenever the LM curves shifts (for reasons other than P), the AD
curve shifts

Monetary and scal policy both shift the AD curve

,! referred to as aggregate demand policies.

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