Which of the following is not a reason for the downward slope of an aggregate demand curve?
a. Wealth effect. b. Real interest-rate effect. c. Exchange-rate effect. d. All of the above are reasons.
The correct answer and explanation is:
The correct answer is d. All of the above are reasons.
The downward slope of the aggregate demand (AD) curve can be explained by three main effects: the wealth effect, the real interest-rate effect, and the exchange-rate effect. These factors contribute to why, as the price level decreases, the quantity of goods and services demanded increases.
- Wealth effect: When the price level falls, the real value of money holdings increases. This means that consumers feel wealthier because the purchasing power of their income has increased. As a result, they are more likely to spend, leading to an increase in the quantity of goods and services demanded.
- Real interest-rate effect: A decrease in the price level often leads to lower interest rates. Lower interest rates reduce the cost of borrowing, which encourages both consumers and businesses to take loans for spending and investment. Increased spending and investment boost the overall demand for goods and services.
- Exchange-rate effect: When domestic price levels fall, the value of a country’s currency may decrease relative to foreign currencies. This makes exports cheaper for foreign buyers, leading to an increase in exports. As exports rise, aggregate demand increases, shifting the AD curve to the right.
All of these effects contribute to the downward slope of the AD curve. Therefore, none of these effects can be singled out as not being reasons for the downward slope. The combined influence of these effects explains why, as the price level falls, the quantity of goods and services demanded by households, businesses, and governments tends to rise.