MARSHALLIAN CROSS

In contrast to the Keynesian Cross Model, the Marshallian Cross Model uses classic demand and supply theory to measure changes in output and prices but on a macroeconomic level.

As in the usual microeconomic context, aggregate demand (AD) is shown as downward sloping. However, on a macroeconomic basis, this is due to the fact if the nominal money supply (MS) is constant, a fall in price P will lead to a rise in the real money supply (MS/P), thus encouraging lower interest rates and higher spending. This is referred to as the Keynes Effect. Therefore, with reference to figure x, an increase in aggregate demand will shift the AD curve to the right, resulting in a corresponding increase in output Y.

However, in the Marshallian Cross model, a long-run aggregate supply curves which is perfectly vertical. This is because with the economic resources within the economy being limited, the maximum potential output will be restricted to Y* – regardless of the general level of prices within the economy. What this implies is that while increased aggregate demand will still result in increased production, the extent of this increase will be determined by whether the economy is operating above or below maximum capacity at Y*. If below, an increase in aggregate demand will lead to a greater increase in output with a lower increase in price levels.

However, if operating above maximum capacity, the same increase in aggregate demand will lead to a much lower increase in production and a much higher increase in prices. This gives rise to the upward sloping gradient of the aggregate supply curve represented by AS.