Final answer:
The aggregate demand curve slopes downward due to the wealth effect, interest rate effect, and foreign price effect, which together reduce the quantity of total spending as price levels rise.
Step-by-step explanation:
The aggregate demand curve slopes downward for several reasons, illustrating that as the price level rises, the quantity of total spending on domestic goods and services declines. This relationship is due to impacts such as:
- The wealth effect: higher price levels result in lower real wealth, which reduces consumption.
- The interest rate effect: higher price levels lead to an increased demand for money, raising interest rates and thereby reducing investment spending.
- The foreign price effect: an increase in the price level makes domestic goods more expensive relative to foreign goods, reducing exports and potentially leading to an increase in imports.
These effects are somewhat controversial among economists because they are not seen as very large, which is why the aggregate demand curve can be steep, indicating that the change in the quantity of aggregate demand with the price level is not very significant.