Question

1. Explain why the Aggregate Demand curve is downward sloping?

Answer 1

The aggregate demand curve represents the total of consumption, government purchases, investment and net exports at each price level in any period. There are a number of reasons for this relationship. It slopes downward because of the wealth effect on consumption, the interset rate effect on investment, and the international trade effect on net exports. The first reason for the downward slope of the aggrgate demand curve is that the nominal value is fixed but the real value is dependent on price level, because for a given amount of money, a lower price level provides more purchasing power per unit of currency. The second reason is that the quantity of money demanded upon the price level i.e, a high price level means that it takes a relatively large amount of currency to make purchases. So, consumers demand range quantities of currency when the price level in high. And when the price level is low, consumers demanded a relatively small amount of currency to make purchase.

The third reason is that the price level falls the interset rate also falls. And when domestic interest rate is relatively low im foreign countries, domestic investor tend to invest in foreign countries where return on investment is higher. As domestic currency flows to foreign countries. The real exchange rate decreases because the international supply of dollars increase. An a decrease in the real exchange rate has the effect of increasing net exports because domestic goods and services are cheaper relatively.