Answer to Question #243910 in Microeconomics for Dilini

Question

Derive aggregate demand (AD) curve using IS-LM model and explain in words

Answer 1

The aggregate demand curve indicates the inverse relationship between aggregate price level and national income level.

If nominal money supply is held constant and the price levels rise, the supply of real money balances will decline. This results in a leftward shift in the LM curve. Interest rates rise while income falls. As price levels rise, income level drops. This relation is shown by the aggregate demand curve.

We conclude therefore that the aggregate demand curve is a locus of points that indicates the alternative combinations of price and income that maintains equilibrium of the goods market and the money market. This equilibrium is shown by the intersection point of the IS and LM curves.