Derivation of Aggregate Demand Curve (With Diagram)

Read this article to learn about Derivation of Aggregate Demand Curve which is explained with diagrams!

AD curve shows negative relationship between the price level and the income level (output).

All variables of IS curve are real variables and therefore are not affected by the prices. However, when price changes e.g. falls, real money supply changes, that is, increases and thus, the LM curve is affected (shifts to right).

If price falls from P₁ to P₂

Real Money supply/balances rises from M/P₁ to M/P₂

Result:

LM curve shifts to the right from LM₁ to LM₂

RER falls from є₁ to є₂

Equilibrium income level rises from Y₁ to Y₂.

Plotting combination of Y₂ and P₂ in the lower panel (Fig. b) we get point S

Join points R and S we get the AD curve which is negatively sloped.