Question

Which of the following explains why the aggregate demand curve slopes downward? a) The interest-rate effect, the real-balances effect, and the foreign purchases effect b) The investment effect, the real-purchases effect, and the foreign purchases effect c) The interest-rate effect, the real-purchases effect, and the foreign purchases effect d) The investment effect, the real-balances effect, and the international effect

Answer 1

Option (a) is correct.

Step-by-step explanation:

Real balance effect: This effect states the relationship between the price level and the purchasing power of the consumer. If there is a higher price level in an economy then this will reduce the purchasing power of the consumers and results in a fall in investment expenditure, net exports and consumption expenditure. That's why aggregate demand curve is slopes downward.

Interest-rate effect: This effect states the cost of borrowing funds with the price inflation in an economy. If there is a higher interest rate then most of the consumers cut down there borrowings activities which is one of the reason of downward sloping demand curve.

Foreign purchases effect: When there is a fall in the price level then as a result the price in the United states falls relative to the foreign prices. Hence, there is an increase in the U.S exports and decrease in the U.S imports.