downward sloping aggregate demand curve

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Figure %: Graph of the accumulation demand curve.The most noticeable feature of the accumulation demand curve is that it is bottom sloping, as viewed in . There room a number of reasons because that this relationship. Recall that a bottom sloping accumulation demand curve way that as the price level drops, the quantity of calculation demanded increases. Similarly, together the price level drops, the national earnings increases. There space three an easy reasons because that the bottom sloping accumulation demand curve. These room Pigou"s wealth effect, Keynes"s interest-rate effect, and Mundell-Fleming"s exchange-rate effect. This three reasons for the downward sloping aggregate demand curve space distinct, however they job-related together.

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The first reason for the bottom slope of the accumulation demand curve is Pigou"s wealth effect. Recall that the nominal value of money is fixed, yet the real value is dependent upon the price level. This is since for a provided amount the money, a reduced price level provides an ext purchasing power per unit of currency. Once the price level falls, consumers room wealthier, a condition which induces more consumer spending. Thus, a fall in the price level induces consumers to spend more, thereby enhancing the aggregate demand.

The 2nd reason because that the downward slope the the aggregate demand curve is Keynes"s interest-rate effect. Recall the the amount of money demanded is dependent upon the price level. That is, a high price level method that the takes a relatively large amount of money to make purchases. Thus, consumer demand big quantities of money when the price level is high. When the price level is low, consumers need a relatively small quantity of currency since it take away a fairly small lot of money to do purchases. Thus, consumers keep larger quantities of currency in the bank. Together the amount of money in banks increases, the it is provided of loan increases. As the supply of loans increases, the expense of loans--that is, the interest rate--decreases. Thus, a low price level induces consumers to save, which consequently drives under the attention rate. A low attention rate increases the need for invest as the expense of investment drops with the attention rate. Thus, a fall in the price level to reduce the interest rate, which increases the demand for investment and also thereby increases accumulation demand.

The 3rd reason because that the downward slope the the accumulation demand curve is Mundell-Fleming"s exchange-rate effect. Remind that as the price level drops the attention rate also tends to fall. When the domestic interest rate is low relative to attention rates obtainable in foreign countries, residential investors often tend to invest in foreign countries where return on invest is higher. As domestic currency flows to international countries, the actual exchange rate decreases due to the fact that the international supply of dollars increases. A to decrease in the real exchange rate has the result of boosting net exports since domestic goods and also services are relatively cheaper. Finally, boost in network exports increases aggregate demand, as net exports is a ingredient of accumulation demand. Thus, as the price level drops, interest rates fall, residential investment in foreign nations increases, the genuine exchange price depreciates, net exports increases, and accumulation demand increases.

IS-LM model of accumulation demand

There is another significant model the is useful for explaining the nature the the aggregate demand curve. This model is dubbed the IS-LM model after the two curves that are involved in the model. The IS curve explains equilibrium in the sector for goods and services wherein Y = C(Y - T) + I(r) + G and the LM curve describes equilibrium in the money market where M/P = L(r,Y). The IS-LM design exists in a plane with r, the attention rate, on the vertical axis and also Y, being both income and also output, on the horizontal axis. The IS-LM model has actually the exact same horizontal axis as the accumulation demand curve, yet a different vertical axis.

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Figure %: Graph the the IS-LM curves.

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The IS curve explains equilibrium in the market for goods and services in terms of r and Y. The IS curve is bottom sloping due to the fact that as the interest rate falls, investment increases, thus increasing output. The LM curve explains equilibrium in the sector for money. The LM curve is upward sloping because higher income results in greater demand because that money, thus resulting in higher interest rates. The intersection of the IS curve with the LM curve mirrors the equilibrium interest rate and also price level.