Question

Do the following:

1. Derive the Ys (aggregate supply) curve in the classical model
2. Derive the Yd (aggregate demand) curve in the classical model
3. Prove that a decline in velocity will shift the Yd (aggregate demand) curve

Please provide graphs/diagrams along with your explanation.

Answer 1

a) Aggregate supply curve in the classical model is vertical and illustrates that economy is always at its full potential level.

b) Aggregate demand curve in the classical model is downward sloping which illustrates a negative relationship between price and quantity demanded.

c) A fall in velocity of money will reduce the circulation of money and people will have less money in their hands which will reduce their willingness to pay for goods and reduce aggregate demand in the economy and shift aggregate demand curve from AD to AD1 which will result in fall in price level from P to P1 while output remains the same at Y.