In micro, demand curves slope down because buyers switch to the cheaper good. In macro, aggregate demand has nothing to switch to. All prices move together instead.
When the whole price level falls, the 💰 money in your wallet buys more. Feeling richer, people spend more. Interest rates also fall, so borrowing gets cheaper. 🧑 Foreigners buy more of our goods too. Together, these three paths raise spending. When the central bank prints more money, the whole curve itself shifts right.
For example, imagine every price at the corner 🏪 shop drops to half overnight. Your allowance stays the same, but it now buys twice as many 🍬 candies. You and your classmates all buy more than before. Nobody switched shops — every wallet simply got twice as fat.
The central bank printed nothing, yet the price level halves one day (P:1→0.5).
What happens to aggregate demand?
Price level 0.5, money 100 — same money, half the prices.Show proof
Real balances are M/P=100/0.5=200, a full 100 above the baseline of 100 — the money in everyone's wallet suddenly buys twice as much.
The extra balances fan out through three channels: wealth +30, interest +50, exchange rate +20. Together, Y=1000+100=1100.
Notice what did not happen: nobody switched to a cheaper good. Every price fell together, so there was nothing to substitute toward — this is not the micro substitution effect at all.
Answer
Y=1100
This time prices stay put and the central bank doubles the money supply (M:100→200).
How far does this match the previous problem, and where does it differ?
Real balances are 200/1=200, exactly as in the previous problem. The same gap Δ=+100 means the same channel sum, so Y=1100 again.
The difference is how we got here. Last time we slid down along one curve; this time the whole curve moved right — the dashed curve left behind is the AD from before the printing.
And here is the trap: if prices also double in response, real balances fall back to 200/2=100 and the effect evaporates. This is the seed of long-run neutrality.