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True or False: one reason that the aggregate demand curve slopes downward is that when...

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mad31 | eNotes Newbie

Posted October 20, 2013 at 10:54 PM via web

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True or False: one reason that the aggregate demand curve slopes downward is that when prices rise, say in the US, the relative price of imports fall and thus, US citizens substitute away from domestically produced goods toward imported goods and thus, GDP in the US will fall (all else constant)

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted October 20, 2013 at 11:18 PM (Answer #1)

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This statement is true.  This is one of the factors that cause the aggregate demand curve to slope downwards.  Economists often call this the “net exports effect.”  However, the statement that you give here does not reflect the complete nature of the net exports effect.

When prices in the US go up, American goods do, as you say, become more expensive relative to imports.  People start buying imports instead of domestic goods.  This causes the demand for domestic goods to decrease, which is reflected in a decrease in aggregate demand.  However, there is another aspect to this effect.  When American goods become more expensive, they also become less attractive to foreign buyers.  Foreigners do not want to import American goods if they are going to be expensive.  This means that an increase in the price level makes American exports decrease even as imports from other countries increase.  So there is something of a “double whammy” at work here.  The rising price level makes the demand for American goods fall both at home and abroad.  Therefore, the statement you have given is true, but is not a complete statement of the net exports effect.


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