11.4 Conclusion

The purpose of this chapter and the previous one has been to deepen our understanding of aggregate demand. We now have the tools to analyze the effects of monetary and fiscal policy in the long run and in the short run. In the long run, prices are flexible, and we use the classical analysis of Part Two of this book. In the short run, prices are sticky, and we use the IS–LM model to examine how changes in policy influence the economy.


Although the model in this chapter and the previous chapter provides the basic framework for analyzing the economy in the short run, it is not the whole story. Future chapters refine the theory. In Chapter 12 we examine how international interactions affect the theory of aggregate demand; in Chapter 13 we examine the theory behind short-run aggregate supply; and in Chapter 14 we bring these various elements of aggregate demand and aggregate supply together to study more precisely the dynamic response of the economy over time. In Chapter 15 we consider the how this theoretical framework should be applied to the making of stabilization policy. In addition, in later chapters, we examine in more detail the elements of the ISLM model, thereby refining our understanding of aggregate demand. In Chapter 17, for example, we study theories of consumption. Because the consumption function is a crucial piece of the IS–LM model, a deeper analysis of consumption may modify our view of the impact of monetary and fiscal policy on the economy. The simple IS–LM model presented in Chapters 10 and 11 provides the starting point for this further analysis.