Question

1) Define aggregate demand. 

2) Give three reasons why the aggregate demand curve slopes downward.

Answer 1

1.aggregate demand:

Definition:

Aggregate demand is a schedule or curve that shows the various amounts of real domestic output that domestic and foreign buyers will desire to purchase at each possible price level.

explanation:

Aggregate Demand refers to the total demand for final goods and services produced in an economy at a particular time.It equals GDP in the long run after adjustment for price level is made.It also is calculated using the same equation as GDP which is AD=C+I+G+(X-M).It follows the law of demand that ceteris paribus,people's demand for goods increases when price decreases and so it has the same curve as the demand curve.

2. three reasons why the aggregate demand curve slopes downward.:

Aggregate demand curve slopes downward because of three reasons which follows that as price decreases,the aggregate demand increases.

The reasons are as follows:

Real balances effect: When price level falls, the purchasing power of existing financial balances rises, which can increase spending.

As a lower level of price means that the purchasing power of people increases so the consumers become wealthier when price drops which will increase spending and so increasing the aggregate demand.

Interest‑rate effect: A decline in price level means lower interest rates that can increase levels of certain types of spending.

when the price decreases,the demand for money decreases as the consumers can purchase the goods at low prices and will keep more money in the bank.When there is more money with the banks,the banks will offer more loans which will increase the supply of loans.As the supply of loan increases,the interest rate falls which will increase the demand for investments which increases aggregate demand.

Foreign purchases effect: When price level falls, other things being equal, U.S. prices will fall relative to foreign prices, which will tend to increase spending on U.S. exports and also decrease import spending in favor of U.S. products that compete with imports.

When the price decreases,the interest rate falls.The lower domestic interest rate in comparison to foreign countries,domestic investors will invest in foreign countries for higher returns which will increase the flow of domestic currency to foreign countries which will result in fall of real exchange rate.The cheaper domestic currency will increase net exports which will result in increase in aggregate demand.