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BPEA Article

The Impact of Aggregate Demand on Prices


DIFFERING IMPLICIT assumptions regarding the response of the aggregate price level to changes in aggregate demand underlie many of the most important disputes in the field of macroeconomics, both at the abstract level of theoretical discussion and at the practical level of policy recommendation. When aggregate demand shifts in either direction, so does the "market-clearing" aggregate price level at which output remains fixed. A "perfectly flexible" actual price level shifts instantaneously to the marketclearing level in response to a shift in demand, but an "imperfectly flexible" price level changes only gradually toward the market-clearing level, thus allowing real output to vary in the same direction as the demand shift during the transition to complete price adjustment.



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