Worth: Mankiw Economics 5e HAPTER 9 Introduction to Economic Fluctuations 243 figure 9-2 Price level. P The Aggregate Demand Curve The aggregate demand curve AD shows the relationship betweer he price level P and the quantity of goods and services demanded Y, It is drawn for a given value of the money supply M. The aggre gate demand curve slopes down ward: the higher the price level the lower the level of real balances M/P, and therefore the lower the quantity of goods and services Income, output, Y Why the Aggregate Demand Curve Slopes Downward As a strictly mathematical matter, the quantity equation explains the downward slope of the aggregate demand curve very simply. The money supply M and the velocity of money V determine the nominal value of output PY. Once PY is fixed, if P goes up, Y must go down. What is the economics that lies behind this mathematical relationship? For a omplete answer, we have to wait for a couple of chapters. For now, however consider the following logic: Because we have assumed the velocity of money is fixed, the money supply determines the dollar value of all transactions in the economy.(This conclusion should be familiar from Chapter 4. If the price level rises, each transaction requires more dollars, so the number of transactions and hus the quantity of goods and services purchased must fall We can also explain the downward slope of the aggregate demand curve by thinking about the supply and demand for real money balances. If output is higher, people engage in more transactions and need higher real balances M/P. For a fixed money supply M, higher real balances imply a lower price level. Con- versely, if the price level is lower, real money balances are higher; the higher level of real balances allows a greater volume of transactions, which means a greater quantity of output is demanded. Shifts in the Aggregate Demand Curve The aggregate demand curve is drawn for a fixed value of the money supply. In other words, it tells us the possible combinations of P and Y for a given value of M. If the Fed changes the money supply, then the possible combinations of P and Y change, which means the aggregate demand curve shifts User JOENA: Job EFFo1425: 6264_ch09: Pg 243: 27135#/eps at 100*mli wed,Feb13,200210:084User JOEWA:Job EFF01425:6264_ch09:Pg 243:27135#/eps at 100% *27135* Wed, Feb 13, 2002 10:08 AM Why the Aggregate Demand Curve Slopes Downward As a strictly mathematical matter, the quantity equation explains the downward slope of the aggregate demand curve very simply.The money supply M and the velocity of money V determine the nominal value of output PY. Once PY is fixed, if P goes up, Y must go down. What is the economics that lies behind this mathematical relationship? For a complete answer, we have to wait for a couple of chapters. For now, however, consider the following logic: Because we have assumed the velocity of money is fixed, the money supply determines the dollar value of all transactions in the economy. (This conclusion should be familiar from Chapter 4.) If the price level rises, each transaction requires more dollars, so the number of transactions and thus the quantity of goods and services purchased must fall. We can also explain the downward slope of the aggregate demand curve by thinking about the supply and demand for real money balances. If output is higher, people engage in more transactions and need higher real balances M/P. For a fixed money supply M, higher real balances imply a lower price level. Con￾versely, if the price level is lower, real money balances are higher; the higher level of real balances allows a greater volume of transactions, which means a greater quantity of output is demanded. Shifts in the Aggregate Demand Curve The aggregate demand curve is drawn for a fixed value of the money supply. In other words, it tells us the possible combinations of P and Y for a given value of M. If the Fed changes the money supply, then the possible combinations of P and Y change, which means the aggregate demand curve shifts. CHAPTER 9 Introduction to Economic Fluctuations | 243 figure 9-2 Price level, P Income, output, Y Aggregate demand, AD The Aggregate Demand Curve The aggregate demand curve AD shows the relationship between the price level P and the quantity of goods and services demanded Y. It is drawn for a given value of the money supply M. The aggre￾gate demand curve slopes down￾ward: the higher the price level P, the lower the level of real balances M/P, and therefore the lower the quantity of goods and services demanded Y