An Increase in Aggregate Demand

In the previous chapters, we gave a number of examples in which an increase in aggregate demand would lead to increased production and employment. But those examples were incomplete, in that they did not allow for aggregate supply. To put the whole AS/AD model to work, let's reconsider some of those examples, and see what difference it makes when we allow for supply -- in the short run and also in the long run.

For example, we have seen that monetary policy could lead to an expansion of aggregate demand. If the monetary authority were to expand the money supply, that would increase the supply of loans, push down the real interest rate, and that would stimulate investment, which, through the multiplier effect, would increase aggregate demand. But what happens then, when we allow for aggregate supply?

The Graphic View