THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 653

CHAPTER 24 Aggregate Demand and Supply Analysis 621 demanded (P* + Yad c), and so the aggregate demand curve slopes down as in Figure 24-1 Schematically, we can write the mechanism just described as follows: P * + M/P c + i * + I c + Y ad c Another mechanism that generates a downward-sloping aggregate demand curve operates through international trade Because a lower price level (P *) leads to a larger quantity of money in real terms (M/P c) and lower interest rates (i *), Canadian-dollar assets become less attractive relative to assets denominated in foreign currencies, thereby causing a fall in the value of dollar assets relative to other currency assets (a decline in the exchange rate, denoted by E *) The lower value of the dollar, which makes domestic goods cheaper relative to foreign goods, then causes net exports to rise (NX c), which in turn increases aggregate demand (Y ad c): P * + M/P c + i * + E * + NX c +Y ad c The fact that the aggregate demand curve is downward sloping can also be derived from the quantity theory of money analysis in Chapter 21 The equation of exchange, MV = PY, indicates that if velocity stays constant, a constant money supply (M) implies that nominal aggregate spending (PY) is also constant When the price level falls (P *), aggregate demand must necessarily rise (Yad c) to keep aggregate spending at the same level Factors That Shift the Aggregate Demand Curve The quantity theory analysis shows that an increase in the money supply (M c) shifts the demand curve to the right, because with velocity constant the higher money supply raises nominal aggregate spending (PY c) and hence at a given price level the quantity of aggregate demand increases (Yad c) An increase in the quantity of money increases the quantity of aggregate demand at each price level and shifts the aggregate demand curve to the right from AD1 to AD2 in Figure 24-1 A components approach to aggregate demand also indicates that changes in the money supply cause the aggregate demand curve to shift via the two mechanisms shown in the schematics above For a given price level, a rise in the money supply causes the real money supply to increase (M/P c), which leads to a decline in interest rates (i *), an increase in investment and net exports (I, NX c), and an Aggregate Price Level, P AD1 AD2 Aggregate Output, Y FIGURE 24-1 Aggregate Demand Curve A decrease in taxes (T *) or an increase in the money supply (M c), government expenditure (G c), net exports (NX c), or business or consumer optimism (C c, I c) increases aggregate demand at each aggregate price level and shifts the aggregate demand curve from AD1 to AD2