Edited by Mark Blaug and Peter Lloyd
Chapter 49: The Aggregate Demand Aggregate Supply Diagram
Richard G. Lipsey The aggregate demand and aggregate supply curves are designed to apply simple Keynesian income-flow models to situations in which the price level and national income are endogenous variables, affected by both supplyside and demand-side shocks. THE DERIVATION OF THE AGGREGATE DEMAND CURVE A simple Keynesian model can be laid out in five equations: (49.1) the division of real expenditure, E, into three parts, one that is positively related to real income, Y, one that is negatively related to the interest rate1, R, and one that is autonomous, a; (49.2) an equilibrium condition of the goods market that desired expenditure should equal actual income;2 (49.3) the real demand for money, Md, which varies positively with real income and negatively with the interest rate, R; (49.4) the assumption that the central bank holds the nominal supply of money, Ms constant at some value M*; (49.5) the equilibrium condition that the real demand for money equals the real supply Ms/P, where P is the price level.3 Stated in linear form, these relations are: E = a + zY+ bR (bY* causes wages and other costs to rise, shifting the SRAS curve to the left until full equilibrium is restored at E2, indicating the original level of income, Y*, and a higher price level. A fall in aggregate demand when income is originally at Y* has the reverse effects, first lowering income and the price level. Then, as excess supply (Y Y*, is faster than the adjustment to excess supply, Y...
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