Marshallian Cross
Sometimes, especially in textbooks, "aggregate demand" refers to an entire demand curve that looks like that in a typical Marshallian supply and demand diagram.
Thus, that we could refer to an "aggregate quantity demanded" (Yd = C + Ip + G + NX in real or inflation-corrected terms) at any given aggregate average price level (such as the GDP deflator), P.
In these diagrams, typically the Yd rises as the average price level (P) falls, as with the AD line in the diagram. The main theoretical reason for this is that if the nominal money supply (Ms) is constant, a falling P implies that the real money supply (Ms/P)rises, encouraging lower interest rates and higher spending. This is often called the "Keynes effect."
Carefully using ideas from the theory of supply and demand, aggregate supply can help determine the extent to which increases in aggregate demand lead to increases in real output or instead to increases in prices (inflation). In the diagram, an increase in any of the components of AD (at any given P) shifts the AD curve to the right. This increases both the level of real production (Y) and the average price level (P).
But different levels of economic activity imply different mixtures of output and price increases. As shown, with very low levels of real gross domestic product and thus large amounts of unemployed resources, most economists of the Keynesian school suggest that most of the change would be in the form of output and employment increases. As the economy gets close to potential output (Y*), we would see more and more price increases rather than output increases as AD increases.
Beyond Y*, this gets more intense, so that price increases dominate. Worse, output levels greater than Y* cannot be sustained for long. The AS is a short-term relationship here. If the economy persists in operating above potential, the AS curve will shift to the left, making the increases in real output transitory.
At low levels of Y, the world is more complicated. First, most modern industrial economies experience few if any falls in prices. So the AS curve is unlikely to shift down or to the right. Second, when they do suffer price cuts (as in Japan), it can lead to disastrous deflation
Thus, that we could refer to an "aggregate quantity demanded" (Yd = C + Ip + G + NX in real or inflation-corrected terms) at any given aggregate average price level (such as the GDP deflator), P.
In these diagrams, typically the Yd rises as the average price level (P) falls, as with the AD line in the diagram. The main theoretical reason for this is that if the nominal money supply (Ms) is constant, a falling P implies that the real money supply (Ms/P)rises, encouraging lower interest rates and higher spending. This is often called the "Keynes effect."
Carefully using ideas from the theory of supply and demand, aggregate supply can help determine the extent to which increases in aggregate demand lead to increases in real output or instead to increases in prices (inflation). In the diagram, an increase in any of the components of AD (at any given P) shifts the AD curve to the right. This increases both the level of real production (Y) and the average price level (P).
But different levels of economic activity imply different mixtures of output and price increases. As shown, with very low levels of real gross domestic product and thus large amounts of unemployed resources, most economists of the Keynesian school suggest that most of the change would be in the form of output and employment increases. As the economy gets close to potential output (Y*), we would see more and more price increases rather than output increases as AD increases.
Beyond Y*, this gets more intense, so that price increases dominate. Worse, output levels greater than Y* cannot be sustained for long. The AS is a short-term relationship here. If the economy persists in operating above potential, the AS curve will shift to the left, making the increases in real output transitory.
At low levels of Y, the world is more complicated. First, most modern industrial economies experience few if any falls in prices. So the AS curve is unlikely to shift down or to the right. Second, when they do suffer price cuts (as in Japan), it can lead to disastrous deflation