The IS/LM Model with Flexible Prices
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.
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.
The Aggregate Supply Curve is not vertical. Keynesians believe that changes in the nominal price level can have real effects on output.
The EconModel presentation shows the model with the AS/AD diagram as an extension of the basic IS/LM Model.
The EconModel presentation explains the following curves:
Aggregate Demand Curve
Aggregate Supply Curve
The EconModel presentation analyzes the effects of changes in:
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.)