Question

The following graph shows the aggregate demand curve in a hypothetical economy. Assume that the economy's money supply remains fixed Aggregate Demand 160 Aggregate Demand 150 140 130 120 02 110 t 100 90 80 0 100 200 300 400 5 600 700 800 REAL GDP (Billions of dollars) Which of the following are reasons the aggregate demand curve is downward sloping? Check all that apply. A lower price level leads to a lower interest rate. A higher price level makes domestically produced goods more expensive than foreign goods. A lower price level increases consumption through the income effect. As the aggregate price level rises, the purchasing power of households' saving balances will causing the quantity of output demanded to This phenomenon is known as the effect.

Answer 1

1. Aggregate demand curve is download sloping because-

At lower price levels, interest rates are low. This means that there would be more investment and thus higher Aggregate demand [Remember, Aggregate demand=Consumption+ Investment +Governmen spending+ (Exports-Imports)]. Low price leads to high aggregate demand, thus, negative slope

A higher price level means that domestic product are expensive than foreign products, and hence, imports of the country will rise. Since imports reduce aggregate demand, the aggregate demand will fall. Thus, higher price leads to low AD- inverse relationship and thus downward slope

A lower price increases Consumption through income effect. And since Consumption increase aggregate demand, increase in Consumption will increase aggregate demand. Thus, lower price leads to higher Aggregate demand- negative relationship and hence downward sloping curve.

Thus, all three options are right.

2. As aggregate price level rises, the purchasing power of household savings will FALL (because the same amount of money can now buy less amount of goods), causing the quantity of output demanded to FALL. This phenomena is called INCOME effect.