Aggregate Demand

The Equation of Exchange

The equation of exchange, often expressed as **M = k P
Y** or **M V = P Y**, plays central roles in both aggregate demand curves
and demand for money. A special page
sorts out these roles for various macroeconomic theories.

The Classical View

The identity **M V = P Y** with **V** fixed implies that, for a fixed **M**,
there is a downward sloping relation between **Y** and **P**.

In the Classical Model, only the money supply can shift the AD curve and the money supply is fixed.

The Keynesian View

Keynesians do a short run analysis of **M V(R) = P Y**, holding **P**
fixed and deriving a relation between **R** and **Y** that is known as the
LM Curve. This is money demand.

Letting **P** change then
produces a relation between **P** and **Y** that is known as the aggregate
demand curve. In the latter analysis, **R** is changing, but is not on
the diagram of **Y** vs. **P**. The aggregate demand curve is linked
to aggregate demand because the changes in **R** cause changes in investment.

In a Keynesian Model, IS curve shocks can move the AD curve and monetary shocks are an important source of fluctuations.

The Monetarist View

The short run monetarist view is that velocity is stable and **P** does not
adjust so that
changes in **M** have to translate into changes in **Y**. It is not
so obvious ...

References

Aggregate Demand,
Wikipedia.

Veocity
of Money, Wikipedia.

Link: Contents