Neoclassical Inflation: Aggregate Demand
The derivation of the aggregate demand curve in the price-output/income space is more problematical than doing the same for aggregate supply. In order that the aggregate demand curve be stable, it is necessary that at each point of the curve all variables affecting aggregate demand other than price be at stable, unchanging values. Perhaps the most important of these other variables is the interest rate. The interest rate will be stable only if the commodity market and the money market are in equilibrium. In other words, the aggregate demand curve in the price/real output space must connect points of intersection of the IS and LM schedules. It is to be recalled that the IS curve traces points of equilibrium between saving and investment, and the LM curve traces points of equality between the demand and supply of money. Thus, the aggregate demand curve is a ‘reduced form’ equation with a vengeance — a super-equilibrium locus constructed on the assumption that two markets are continuously and simultaneously in equilibrium.
KeywordsInterest Rate Money Supply Aggregate Demand Money Market Full Employment
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