Aggregate Demand

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

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.

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

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.

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.