Lent - Lecture 7 - The AD Curve

Question 1

How do we derive the AD curve?

Answer 1

• consider IS-MP
• by varying π, we can trace out an aggregate demand curve
• specifically, lower π implies a cut in r via MP, which raises Y

Question 2

What will AD be shifted by?

Answer 2

anything that affects IS-MP equilibrium

Question 3

What 2 things affect the slope of AD

Answer 3

• how much r responds to π:
• captured by the feedback parameter mπ
• higher mπ → large change in r for small change in π → flatter AD
• how much Y responds to a shift in MP:
• flatter IS curve → flatter AD curve
• larger mY mitigates response → steeper AD

Question 4

By incorporating the ZLB, what does the AD curve look like?

Answer 4

• the ZLB implies a kink in AD
• is starts of downward sloping, and then becomes vertical
• output cannot increase above a certain Y value

Question 5

What happens to the AD curve when π(e) decreases?

Answer 5

-causes an inward shift of the vertical section of the AD curve
- because r cannot fall below -π(e), causing a horizontal section to the MP curve, and hence affecting the vertical section of the AD curve