Page 185 - DECO402_Macro Economics

Macroeconomic Theory Pavitar Parkash Singh, Lovely Professional University

Notes Unit-20: Effect of Monetary Policies Under Different
Cases in IS-LM Framework

Contents
Objectives
Introduction
20.1 Derivation of Aggregate Demand Curve from IS-LM Model
20.2 What Happens if there is Autonomous Change in Money Supply, Independent of
Change in Price Level?
20.3 Summary
20.4 Keywords
20.5 Review Questions
20.6 Further Readings

Objectives

After studying this unit, students will be able to:
y Know the Derivation of Aggregate Demand Curve from IS-LM Model,
y Study the change in Price Level.

Introduction

On the given equilibrium between IS and LM, if there is rise in price level, LM curve shifts towards
left and there is fall in price level, LM curve shifts towards right. It’s reason is that real money supply
decreases from the rise in price level. On being money supply low, LM curve shifts towards left.
On shifting the LM curve towards left, there comes a barrier in the initial equilibrium of real and
monetary fields.

20.1 Derivation of Aggregate Demand Curve from IS-LM Model

We had told in chapter 18 that the Aggregate Demand Curve is found from the joining of coincidences
of actual GDP and Price level. It’s slope is downward which means that the inverse relationship between
price level and actual GDP. The IS-LM Model presents an alternative technique of derivation of AD
curve. It becomes possible only then if we allow the effect of change in price level on LM curve. On
the given equilibrium between IS and LM, if there is rise in price level, LM curve shifts towards left
and there is fall in price level, LM curve shifts towards right. It’s reason is that real money supply
decreases from the rise in price level. On being money supply low, LM curve shifts towards left. On
shifting the LM curve towards left, there comes a barrier in the initial equilibrium of real and monetary
fields. A new equilibrium is found from the lower level of GDP and higher level of interest rate.
Similarly, because of right side shifting of LM curve from the fall in price level, with the higher level
of GDP and lower interest rate, a new equilibrium is established. If we combine the different price

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