Macroeconomics

Deriving the Aggregate Demand Curve with the 

IS–LM Model

Panel (a) shows

the IS–LM model: an increase in the price level from P

1

to P

2

lowers real money bal-

ances and thus shifts the LM curve upward. The shift in the LM curve lowers income

from Y

1

to Y

2

. Panel (b) shows the aggregate demand curve summarizing this rela-

tionship between the price level and income: the higher the price level, the lower the

level of income.

F I G U R E

1 1 - 5

Interest rate, r

Price level, P

Income,

output, Y

Income,

output, Y

Y

1

IS

LM(P

1

)

LM(P

2

)

Y

2

P

2

P

1

Y

1

AD

Y

2

(a) The IS–LM Model

(b) The Aggregate Demand Curve

2. ... lowering

income Y.

1. A higher price

level P shifts the

LM curve upward, ...

3. The AD curve summarizes

the relationship between

P and Y.

---

in the aggregate demand curve. The factors shifting aggregate demand include not

only monetary and fiscal policy but also shocks to the goods market (the IS curve)

and shocks to the money market (the LM curve).

We can summarize these results as follows: A change in income in the IS–LM

model resulting from a change in the price level represents a movement along the aggregate

demand curve. A change in income in the IS–LM model for a given price level represents

a shift in the aggregate demand curve.

C H A P T E R   1 1

Aggregate Demand II: Applying the IS-LM Model

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