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.sub.0]X.
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.
For any given increase of aggregate supply with a negatively sloped aggregate demand curve, the price level will decrease, real GDP will increase, and the net effect on the balance of trade is ambiguous In this case the price level elasticity of demand, by governing the relative strengths of the price level and real GDP changes, determines both the direction of change of the balance of trade and the size of the resultant trade deficit or 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.
The intersection of these aggregate demand curves
and the aggregate supply curve produce the goods market-clearing equilibrium values of [P.sup.H.sub .t], [[Y.sup.H.sub.t], and [P.sup.L.sub.t], [Y.sup.L.sub.t], respectively, portrayed in Figure 2.
For the sake of illustration, the three aggregate demand curves
([AD.sub.1, AD.sub.2, and AD.sub.3]) are assumed to represent the aggregate demand curves
of either Ricardo or Keynes.