The aggregate demand curve slopes downward; why is that?
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The aggregate demand curve slopes downward; why is that?
Reasons for the Downward Slope of the Aggregate Demand Curve
The aggregate demand (AD) curve, which shows the relationship between the overall price level in an economy and the total demand for goods and services, slopes downward due to three primary reasons:
Wealth Effect: As the general price level falls, the real value of money and financial assets increases, enhancing the purchasing power of consumers. This increase in real wealth leads to higher consumer spending, thereby increasing aggregate demand.
Interest Rate Effect: Lower price levels lead to lower demand for money (as less money is needed for transactions), which typically results in lower interest rates. Lower interest rates reduce the cost of borrowing, encouraging both consumer spending and business investment, thus increasing aggregate demand.
Exchange Rate Effect: A decrease in the domestic price level can make domestic goods and services cheaper relative to foreign goods. This can lead to an increase in exports and a decrease in imports, improving the net export component of aggregate demand.
In summary, the aggregate demand curve slopes downward due to the wealth effect, the interest rate effect, and the exchange rate effect, all of which contribute to an increase in total demand as the price level decreases.