The aggregate demand (AD) curve is a negatively sloped line in a diagram that measures the price level along the vertical axis and income along the horizontal one. It generalizes the results derived from the Mundell-Fleming model.

The Mundell-Fleming model assumes prices to be fixed. The AD curve asks how the equilibrium income derived in the Mundell-Fleming model changes if the price level was to change after all. To see how the price level bears on equilibrium income, we start by looking at how the market equilibrium lines, that is FE, LM and IS are affected by changes in the price level:

FE and the price level

LM and the price level

IS and the price level

To find out what the aggregate demand curve looks like, we need to merge the three markets into one diagram. The income levels at which all three market-equilibrium planes intersect at different price levels will then mark the AD curve. Just as when we discussed the Mundell-Fleming model, we need to discuss fixed and flexible exchange rates separately.

AD curve (flexible exchange rates)

AD curve (fixed exchange rates)