The second assumption is that any difference in the price level elasticity of aggregate demand for this paper arises only from either the real balance or interest rate effect, with the corollary being that the price level sensitivity of the balance of trade is assumed equal for aggregate demand curves of different price level elasticities.
Panel A of Figure 1 shows the standard aggregate demand, short-run aggregate supply model expanded to include two aggregate demand curves of different price level elasticities.
Now assume that a positive aggregate demand shock occurs and shifts both aggregate demand curves horizontally by the distance [E.
Panel A of Figure 2 again shows the standard aggregate demand, aggregate supply model expanded with two aggregate demand curves of different elasticities, labeled as before.
2]), again assuming that net exports exhibit the same elasticity with respect to the price level for the two aggregate demand curves.
In general, when aggregate demand is more elastic, the increase in real GDP is larger and the decrease in the price level is smaller such that a balance of trade deficit would be greater or a balance of trade surplus would be smaller than for a less elastic aggregate demand curve.
Beginning with a balance of payments of zero, we have shown that a relatively elastic aggregate demand curve will result in a balance of trade deficit while an inelastic aggregate demand function will cause a balance of trade surplus.
A Note on Macroeconomics Textbooks: The Use of the Aggregate Demand Curve," Journal of Economic Literature, 12: 896-897.
A Comment on 'The Use of the Aggregate Demand Curve,'" Journal of Economic Literature, 13: 472-473.