Question

The reasons why the aggregate demand (AD) curve is downward sloping are Foreign Good Substitution, Wealth Effect, and Interest Rate Effect.

a)false

b)true

c)no text provided

Answer 1

There are three primary reasons why the aggregate demand curve is downward sloping and they are wealth effect, interest rate effect and exchange rate effect. The aggregate demand showing the negative relationship between the price level and the real GDP.

As the price level decreases the purchasing power of people will go up they will feel more richer than before so they increase their quantity demanded at lower prices and decreases at higher prices. The second reason is the interest rate effect, we know that the price level is directly related to the money demand , that is an increase in the price level increases the money demand. At higher price level the purchasing power of money is low so the people have to carry more money to do the transactions and for this they want to withdraw money from the banks. This decreases the bank reserves and a decreases in the reserves will increase the cost of borrowing that is the interest rates. The higher interest rates will decrease the amount of investment since the interest rate is the cost of borrowing. The third one is the exchange rate a lower price level in the economy puts downward pressure on the economy so as the interest rate decreases the investors draw back their funds out of the country and this will have negative effect on the exchange rate . As the exchange rate falls the imports of the country will decrease ,exports increase and the net exports improves so the aggregate demand increases.

Ans: FALSE.