Worth: Mankiw Economics 5e 242 PART IV Business Cycle Theory: The Economy in the Short Run good's price and the quantity sold, and how shifts in supply and demand affect the price and quantity. In the rest of this chapter, we introduce the "economy-size version of this model-the model of aggregate supply and aggregate demand. This macroeconomic model allows us to study how the aggregate price level and the quantity of aggregate output are determined. It also provides a way to contrast how the economy behaves in the long run and how it behaves in the short run. Although the model of aggregate supply and aggregate demand resembles the model of supply and demand for a single good, the analogy is not exact. The model of supply and demand for a single good considers only one good within a large economy. By contrast, as we will see in the coming chapters, the model of aggregate supply and aggregate demand is a sophisticated model that incorpo- rates the interactions among many markets. 9-2 Aggregate Demand Aggregate demand (AD)is the relationship between the quantity of output demanded and the aggregate price level. In other words, the aggregate demand curve tells us the quantity of goods and services people want to buy at any given level of prices. We examine the theory of aggregate demand in detail in Chapters 10 through 12. Here we use the quantity theory of money to provide a simple, although incomplete, derivation of the aggregate demand curve. The Quantity Equation as Aggregate Demand Recall from Chapter 4 that the quantity theory says that MV=PY, where M is the money supply, v is the velocity of money, P is the price level, and Y is the amount of output. If the velocity of money is constant, then this equa You might recall that the quantity equation can be rewritten in terms of the pply and demand for real money balances M/P=(M/p)=kY where k= 1/V is a parameter determining how much money people want to hold for every dollar of income. In this form, the quantity equation states that the supply of real money balances M/P equals the demand (M/p)and that the de- mand is proportional to output Y. The velocity of money V is the "flip side" of the money demand parameter k For any fixed money supply and velocity, the quantity equation yields a nega- tive relationship between the price level P and output Y. Figure 9-2 graphs the combinations of P and Y that satisfy the quantity equation holding M and V constant.This downward-sloping curve is called the aggregate demand curve User JOENA: Job EFFo1425: 6264_ch09: Pg 242: 27134#/eps at 100*ml Wea,Feb13,200210:08AMUser JOEWA:Job EFF01425:6264_ch09:Pg 242:27134#/eps at 100% *27134* Wed, Feb 13, 2002 10:08 AM good’s price and the quantity sold, and how shifts in supply and demand affect the price and quantity. In the rest of this chapter, we introduce the “economy-size’’ version of this model—the model of aggregate supply and aggregate demand. This macroeconomic model allows us to study how the aggregate price level and the quantity of aggregate output are determined. It also provides a way to contrast how the economy behaves in the long run and how it behaves in the short run. Although the model of aggregate supply and aggregate demand resembles the model of supply and demand for a single good, the analogy is not exact. The model of supply and demand for a single good considers only one good within a large economy. By contrast, as we will see in the coming chapters, the model of aggregate supply and aggregate demand is a sophisticated model that incorpo￾rates the interactions among many markets. 9-2 Aggregate Demand Aggregate demand (AD) is the relationship between the quantity of output demanded and the aggregate price level. In other words, the aggregate demand curve tells us the quantity of goods and services people want to buy at any given level of prices.We examine the theory of aggregate demand in detail in Chapters 10 through 12. Here we use the quantity theory of money to provide a simple, although incomplete, derivation of the aggregate demand curve. The Quantity Equation as Aggregate Demand Recall from Chapter 4 that the quantity theory says that MV = PY, where M is the money supply,V is the velocity of money, P is the price level, and Y is the amount of output. If the velocity of money is constant, then this equa￾tion states that the money supply determines the nominal value of output, which in turn is the product of the price level and the amount of output. You might recall that the quantity equation can be rewritten in terms of the supply and demand for real money balances: M/P = (M/P) d = kY, where k = 1/V is a parameter determining how much money people want to hold for every dollar of income. In this form, the quantity equation states that the supply of real money balances M/P equals the demand (M/P) d and that the de￾mand is proportional to output Y.The velocity of money V is the “flip side” of the money demand parameter k. For any fixed money supply and velocity, the quantity equation yields a nega￾tive relationship between the price level P and output Y. Figure 9-2 graphs the combinations of P and Y that satisfy the quantity equation holding M and V constant.This downward-sloping curve is called the aggregate demand curve. 242 | PART IV Business Cycle Theory: The Economy in the Short Run