The purpose of this appendix is to present the graphical derivation of the AD curve in its simplest form. This derivation utilizes the 45 -line diagram (expounded in appendix 4.3) in figure 5.7 to derive the AD curve in figure 5.8.
In figure 5.7 we begin with price level PA which gives rise to aggregate expenditure line AEPA putting the economy at equilibrium point A. At point A the price level is PA and income is YA, shown in figure 5.8 as point AA. Suppose now that the price level increases to PB. This increase causes the wealth effect and other phenomena to operate to decrease aggregate demand for goods and services, shifting the AE down to AEPB, lowering equilibrium income to YB. Thus the higher price level PB corresponds to lower equilibrium income level YB, shown in figure 5.8 as paint BB.
Figures 5.7 and 5.8 show that the AD curve is downward-sloping. They also make clear that the AD curve is better described as an "equilibrium" curve: for each price level it tells us what level of income would have to prevail to create equilibrium in the goods and services submarket of the macroeconomy. This version of the AD curve is very simple; it rep-
Figure 5.7 Deriving the AD Curve A rise in price from PA to PB shifts the AE curve down to AEPB, changing the equilibrium point from A to B. The higher price level PB is matched with the lower income level YB in Figure 5.8.
