e) LIST the three effects that account for the downward slope of the AD curve.

Expert Solution

The three reasons for the downward sloping AD curve are:

1) Wealth effect: The increase in the price reduces the nominal value of money, which means that less can be now bought with the same amount of money. Therefore, when prices rise, the consumers tend to spend less on goods and services.

2) Interest rate effects: The increase in price price levels forces people to keep more currency in hand and deposit less in banks. While a drop in prices makes people deposit more money in bank. This leads to availability of more loanable funds, reducing interest rates on loans. Thus lower price level causes lower interest rates, providing cheaper loans to consumers and investors. This increases aggregate demand with decrese in price.

3) Trade effects: As we have seen, lower prices lead to lower interest rate in the domestic market. Lower interest rate pursuades investors to invest their money in foreign countries, which leads to depreciation of domestic currency. This makes makes domestic goods more competitive in the world market and encourages exports. This in turn increases aggregate demand, causing a downward sloping AD curve.

Rahul Sunny answered 1 hour ago

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