Question

Explain why the aggregate demand curve is downward sloping. (As the price level falls, the quantity of real output demanded increases.). List five factors that might cause the AD curve to shift outward (i.e. more is demanded at the same price).

Answer 1

The aggregate demand curve is downward sloping because:

1. Real Income Effect: As price rises, real income i.e. purchasing power falls and hence the consumer can afford fewer quantities of goods and services.

2. Substitution Effect: As the price rises, the relative price of the substitute goods falls and hence consumer spends more on the substitutes. The quantity demanded of the concerned good falls.

3. Several uses of a product: As the price of good falls, the concerned good is put to more important uses only and hence lower demand. When it's price remains low it is put into less important uses as well. Example: Electricity, Milk.

Factors causing AD curve to shift outward:

1. Increase in money income

2. Increase in price of substitutes.

3. Fall in price of complementary goods.

4. Rise in population.

5. A favourable change in tastes and preference.

6. Favourable seasonal influences.

7. Rise in the applicability of the product.