The relationship between the aggregate price level and aggregate output demanded gives the aggregate demand curve a _ slope.
The correct answer and explanation is:
The aggregate demand curve has a downward slope.
The aggregate demand curve represents the total quantity of goods and services that households, businesses, government, and foreign buyers are willing to purchase at different price levels. The downward slope of the curve is due to three main effects:
- Wealth Effect: When the price level falls, the real value of money and wealth increases. People feel wealthier and are more willing to spend. This leads to an increase in the demand for goods and services, which is reflected as a movement along the aggregate demand curve to the right.
- Interest Rate Effect: A lower price level reduces the demand for money since fewer funds are needed for transactions. This leads to a reduction in interest rates, which encourages borrowing and investment. As a result, demand for goods and services increases, contributing to the downward slope.
- Foreign Exchange Effect: If domestic prices decrease, domestic goods become cheaper relative to foreign goods. This causes an increase in exports while reducing imports. As exports rise, aggregate demand increases, reinforcing the downward slope of the aggregate demand curve.
Each of these factors leads to higher demand for goods and services when the price level decreases, resulting in a negative or downward slope for the aggregate demand curve. Conversely, when the price level increases, these effects reverse. The wealth effect leads to reduced consumer spending, the interest rate effect causes higher borrowing costs and reduced investment, and the foreign exchange effect makes domestic goods less competitive internationally. Thus, the downward slope reflects the inverse relationship between the aggregate price level and the quantity of goods and services demanded.