respectively. The aggregate demand
connects the point of
equilibrium.
The aggregate demand therefore, represents combination of
price level and real income which maintain equilibrium in goods
market and money market. It is also known as
Macroeconomic
Demand Schedule (MDS).
The MDS shows different combination of price level and real
income at which planned spending equal actual output, once the
interest rate is set at the level required to keep the money market in
equilibrium.
The MDS or AD curve slopes downwards because the lower
price level increases the real money
supply reduces the interest
rate and thereby it leads to an increase in aggregate demand.
Therefore aggregate demand increases at a lower price level.
The increase in aggregate demand is also due to real balance
effect on consumption caused by fall in price level.
It means that
the real income of people increase and consumption increases due
to the fall in prices of goods and services.
9.2.1 Shift in the MDS and Real Balance Effect
The shift in the real money balance is caused by a shift of IS
curve. The IS curve will shift when factors
like private investment
demand, government spending or any other autonomous part of
Keynesian aggregate demand increases or decreases.
As a result
of fall in the price level, the real value of household
wealth will increase. Therefore there
will be an increase in
autonomous consumption demand. This is known as the Real
Balance Effect.
The real balance effect is
increase in the autonomous
consumption demand when the value of consumption real money
balances increases.
The real balance effect lead to shift of IS curve to the right.
As a result, there will be shift in the MDS as shown in the following
diagram.
