1. The Influence of Monetary and Fiscal Policy on Aggregate Demand34
The Influence of Monetary and Fiscal Policy on Aggregate Demand

2. Figure 1 Equilibrium in the Money Market
Interest
Rate
Money
supply
Money
demand M d r1
Equilibrium
interest
rate r2 M2 d
Quantity fixed
Quantity of
by the central bank
Money
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3. Figure 2 The Money Market and the Slope of the Aggregate Demand Curve
(a) The Money Market
(b) The Aggregate Demand Curve
Interest
Money
Price
Rate
supply
Level
Money demand at
price level P2 ,
MD2
increases the
demand for money . . . r2
Money demand at
price level P , MD P2 Y2
which
increases
the
equilibrium
interest
rate . . .
1. An
increase
in the
price
level . . . r Y P
Aggregate
demand
Quantity fixed
Quantity
Quantity
which in turn reduces the quantity
of goods and services demanded.
by the central bank
of Money
of Output
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4. Figure 3 A Monetary Injection
(a) The Money Market
(b) The Aggregate Demand Curve
Interest
Price
Rate
Money
supply, MS
MS2
Level
AD2
Money demand
at price level P
1. When the central
bank increases the
money supply . . . r Y P
the
equilibrium
interest rate
falls . . . r2
Aggregate
demand, A D
Quantity Y
Quantity
which increases the quantity of goods
and services demanded at a given price level.
of Money
of Output
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5. Figure 4 The Multiplier Effect
Price
Level
AD3
AD2
but the multiplier
effect can amplify the
shift in aggregate
demand.
Aggregate demand,
AD1
£10 billion
1. An increase in government purchases
of £10 billion initially increases aggregate
demand by £10 billion . . .
Quantity of
Output
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6. Figure 5 The Crowding-Out Effect
(a) The Money Market
(b) The Shift in Aggregate Demand
Interest
Price
which in turn
partly offsets the
initial increase in
aggregate demand.
Rate
Money
AD2
Level
supply
AD3
the increase in
spending increases
money demand . . .
£10 billion M D2
1. When an increase in government
purchases increases aggregate
demand . . . r2
which
increases
the
equilibrium
interest
rate . . . r
Aggregate demand, AD1
Money demand, MD
Quantity fixed
Quantity
Quantity
by the central bank
of Money
of Output
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