Alright. So now let's see how the price level affects both the money market and the aggregate demand curve. So remember when we studied the aggregate demand curve, the price level is the y-axis. Right? On the aggregate demand curve, we have the price level here on the y-axis and we have GDP on this axis, right? And what about in our money market? So our x-axis was GDP there. What about in our money market? Our money market, we had the interest rate as the price of money over here and the quantity of money, was down there and remember that the quantity is fixed by the Fed. Right? If the Fed says how much money there is in the market, that's fixed by how much they supply there. So here we have our aggregate demand curve. We'll say at AD1. We've got our money supply and we've got our money demand here as well. Right? So those are all of the curves that we're dealing with. So now let's go through an example and let's see how a change in the price level is going to affect these two graphs. So the general price level increases in the United States. Okay. So we see a general increase. We're going through a period of inflation here. What effects will this have on the following graphs?

So let's start with our aggregate demand curve. Let's think about how it affects aggregate demand. Remember that the price level is our y-axis. So since price level is a component of the graph, it's our y-axis. Just like with any graph, if the y-axis is what's changing, so if the interest rate changes, well, then we're not going to move shift the curve. We're gonna move along the curves. But if the interest rate changes over here, well, that's not part of the graph, right? So that could shift the curves. Here, we have the price level. So if the price level changes, we're not gonna draw a new aggregate demand curve. We're gonna move along the aggregate demand curve. Just like we've studied. When the price of the object changes, we're gonna move along the curve. When an underlying factor changes, that's when we shift the curves. So in the aggregate demand graph, we're gonna see that the price level changing is just gonna move us along this aggregate demand curve. So let's say we started at this price level here. We'll say P_low. The low price, well, we would have been demanding this much GDP. Right? This would have been the GDP₁. Right? The price at the, at the low price, we would have had, that much GDP. But now we're saying price levels increased. So if price levels are increasing to here to a higher price level, well, notice, we're not going to draw a new demand curve here. We're just going to find a new point on this demand curve at this lower GDP. So what's happening here? Is there a is a decrease in GDP when we have a higher price level, right? There's a decrease in in the GDP demanded there because the price levels are higher. We're not gonna spend that much as much at that higher price. So if the price level is changing, how does that affect our money market?

So this is the effect it would have on the aggregate demand is that the price level would lead to a different point on the aggregate demand curve which has a lower GDP. So in the money market, well, remember that the price level affects one of our curves. Does it affect our money supply or our money demand? So remember when we studied money demand, there was the things that shifted the money demand curve and the 2 most important was the price level and the amount of real GDP in the economy. So if the price level increases, remember how we discussed about buying a meal at McDonald's. If you're going to go to McDonald's and there's higher prices, well, you need more cash in your pocket to buy that meal. So if price levels are increasing, we're gonna see an increase in the demand for money. So I'm going to write it over here. Price level increase, Money demand increases. Right? Higher higher prices mean we need more money. We need more cash in this case. So we need to draw a new money demand curve. This will be money demand 1. And at a higher price level, we need more money. So let's shift to the right and draw a new money demand curve over here. So our new money demand is gonna be over here to the right, money demand 2. So now, let's, let's look at our equilibrium in this case. So our original equilibrium was right here where the blue lines crossed and we had an equilibrium r₁, this interest rate r₁. But what's happened is we've reached this higher interest rate by the money demand shifting. So now we're at r₂. There's a higher demand for money. So interest rates increase because the supply hasn't changed. Right? There's the same amount of supply, but there's more demand for that money. So the cost of it is going to go up through these higher interest rates, okay?

So that's how a change in the price level is gonna affect these two graphs. Notice, in the first situation, we affected the interest rate, right? We affected the interest rate which by affecting the interest rate in this graph, we only moved along our demand curve, right? So the Fed wanted to affect the interest rate, so they increase their supply to move us along the money demand curve. And what did that do? It shifted the aggregate demand, right? Because interest rate is not part of this graph. It's an underlying factor of this graph. And down here, we shifted the price level and since we move the price level, it is part of this graph. So we didn't draw a new curve. We just moved along this curve and the change in the price level affected the money demand and we didn't move along it, we shifted the money demand because of the new price level. Alright? So that's how these 2 graphs are interrelated. The price level and the interest rate have effects on both of the graphs. Alright? Let's go ahead and pause here and move on.