Can someone please explain to me why it is downward sloping? I can't get my head around it
Aggregate demand help Watch
- Thread Starter
- 11-04-2013 16:29
- 11-04-2013 17:05
It's due to three effects. 1) Wealth effect. 2) Interest rate effect and 3) trade effect
1) If average price level increases then disposable income drecreases, thus they spend less. Real value of savings decreases as well
2) If average price increases then more money is needed for a transaction to occur (Consider buying 5 units for $1 ea but then it increased to 5 units for $1.2 ea). As the supply of money in an economy is fixed, an increased in money demand will cause interest rates to increase. This decreases both consumption and investment levels.
3) Average price level increase will cause exports to be less competitive overseas, leading to a reduction in net exports.