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Aggregate Demand

Problems

The Aggregate Demand Curve

Shifts in the Aggregate Demand Curve

Problem : According to the aggregate demand curve, what is the effect on output or income of a drop in the price level?

The aggregate demand curve shows that a drop in the price level creates a drop in output or income.

Problem : How does the Mundell-Fleming model explain the downward sloping aggregate demand curve?

The Mundell-Fleming model states that a drop in the price level decreases the interest rate, which increases the demand for investment and thereby increases aggregate demand.

Problem : How does the Pigou model explain the downward sloping aggregate demand curve?

The Pigou model states that a drop in the price level induces consumers to spend more thereby increasing the aggregate demand.

Problem : How does the Keynes model explain the downward sloping aggregate demand curve?

The Keynes model states that a drop in the price level decreases the interest rate, which increases the demand for investment and thereby increases aggregate demand.

Problem : Explain the basics of the IS-LM model.

The IS curve describes equilibrium in the market for goods and services in terms of r and Y. The IS curve is downward sloping because as the interest rate falls, investment increases, thus increasing output. The LM curve describes equilibrium in the market for money. The LM curve is upward sloping because higher income results in higher demand for money, thus resulting in higher interest rates. The intersection of the IS curve with the LM curve shows the equilibrium interest rate and price level.

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