Question

Why does the explanation for the inverse relationship between the price level and quantity demanded depicted by the aggregate demand curve differ from the relationship between price and quantity demanded depicted by a demand curve for a specific good? Check all that apply.

A fall in prices will increase the real wealth of people holding money, which encourages additional consumption.

When the prices of all goods produced domestically fall by the same proportion, there is no incentive for domestic buyers to substitute one good for another.

A fall in the prices of domestic goods relative to those of foreign goods encourages imports, thus decreasing net exports.

A price reduction in the aggregate goods and services market indicates that the level of prices in the entire economy has declined.

Answer 1

Solution:

• One of the reasons of downward sloping of demand curve for a single good is the substitution effect.
• When the price falls the consumers substitute less expensive goods in place of costly goods.
• This leads to an increase in the quantity demanded of the goods for which there is a price fall. But there is no substitution effect among the domestic goods when the aggregate price level falls.

One of the reasons of downward sloping aggregate demand curve is wealth effect. When the price level falls the real wealth of the people increase which induce additional consumption. But in case of demand for a single good a fall in price increase the quantity demanded due to income effect.

A price reduction in aggregate goods and service market means that the price of all goods decreases.

• Thus the demand for all goods and services increases.
• But in case of specific goods, it is the change in price and quantity demanded of a single good and not the fall in aggregate price and increase in aggregate quantity demanded.

A. When the prices of all goods produced domestically fall by the same proportion, there is no incentive for domestic buyers to substitute one good for another.

C. A fall in prices will increase the real wealth of people holding money, which encourages additional consumption.

D. A price reduction in the aggregate goods and services market indicates that the level of prices in the entire economy has declined.

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