Question

What are the three effects that explain why AD curve is downward sloping and the two effects that explain why AS curve is upward sloping? Explain the Real Balance effect and the Foreign Trade effect in detail.

Answer 1

The main components of the aggregate demand are Consumption funtion+investment function+Governmnet spending+Net export increasing these components leads to aggregate demand curve shift right or downwards.

The reason why downward sloping is due following effects

• The price level and consumption-wealth effect
• The price level and investment -interest rate effect
• The Price level and net export -exchange rate effect.

Aggregate supply curve- The main factors influence aggregate supply curve is available of the economic resource in the economy which is not possible increase in the short run.

Increasing the price level the economy leads to more demand hence it encourages to produce more goods thus AS curve upward sloping for the different price level.

Real balance effect inversely related to price level higher the price level lower will be the real balance effect

The foreign trade effect refers to demands on the price level and exchange rate lower the price level export of the country increase and exchange rate appreciation.