Homework Help

True or False:  One reason the aggregate demand curve slopes downward is due to the...

user profile pic

lilylee | Student, College Freshman | Salutatorian

Posted June 24, 2013 at 10:22 PM via web

dislike 1 like

True or False:  One reason the aggregate demand curve slopes downward is due to the fact that if the price level falls, real money balances rise, all else constant, and interest rates will fall causing an incresase in consumption and investment.

1 Answer | Add Yours

user profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted June 24, 2013 at 10:36 PM (Answer #1)

dislike 2 like

This statement is true.  Both of the effects that you mention in this question do have an impact on the fact that the aggregated demand (AD) curve slopes downward.

One of the reasons that the AD curve slopes downward is called the real balances effect.  This has to do with the relationship between price level and our ability to buy things.  If the price level decreases, all else being equal, our money is worth more.  The real value of our money rises.  This means that we can afford more goods or services.  Therefore, the quantity demanded (shown as RGDP) increases as the price level decreases.

A second reason for the slope of the AD curve is the interest rate effect.  When the price level drops, interest rates drop as well.  When interest rates drop, people and firms do not have to pay as much to borrow as they did when rates were higher.  Therefore, they will tend to borrow more money to use on consumption or, in the case of firms, investment.  This means that, once again, quantity demanded rises as the price level falls.

For these reasons, this is a true statement.

Join to answer this question

Join a community of thousands of dedicated teachers and students.

Join eNotes