The IS/LM Model with Flexible Prices

Background

This page is a continuation of the IS/LM Model.

The Aggregate Supply/Aggregate Demand Diagram

Relaxing the assumption that the price level is fixed leads to a more general model with an aggregate supply and demand diagram.

Aggregate Demand

Holding M fixed and changing P changes the real money supply M/P. This has the effect of shifting the LM curve and changing Y. The Aggregate Demand Curve traces out the resulting combinations of Y and P.

Aggregate Supply

The Aggregate Supply Curve is not vertical. Keynesians believe that changes in the nominal price level can have real effects on output.

EconModel

The EconModel presentation shows the model with the AS/AD diagram as an extension of the basic IS/LM Model.

Building Blocks

The EconModel presentation explains the following curves:

Aggregate Demand Curve

Aggregate Supply Curve

Analysis

The EconModel presentation analyzes the effects of changes in:

Money Supply

Government Spending/Taxes

The results emphasize the difference between the short run and long run responses to monetary and fiscal policies given a natural rate of output. (The natural rate of unemployment (NAIRU) is a related concept.)

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Keynesian Models