Question

Which of the following is a reason why the aggregate demand curve slopes downward?

a. Periods when the price level is rising are usually times of swift declines in economic activity.
b. If the U.S. price level rises, foreigners will buy more U.S. goods, leaving fewer U.S. goods for domestic consumers.
c. At a higher price level, fewer goods and services are available.
d. As the price level rises, business leaders become pessimistic about the future and reduce production.
e. Households feel poorer with an increase in average prices.

Answer 1

The aggregate demand curve slopes downward primarily because of option (e): as average prices increase, households feel poorer and reduce consumption, known as the wealth effect. Additionally, the interest rate effect and foreign price effect also contribute to the downward slope.

Step-by-step explanation:

The reason the aggregate demand curve slopes downward is option (e): Households feel poorer with an increase in average prices. This is known as the wealth effect, which is one of the three primary reasons for the downward slope. When average price levels rise, the real value of money decreases, making consumers feel less wealthy, leading to a reduction in consumption. Additionally, two other effects contribute to the downward slope of the AD curve: the interest rate effect, where higher prices lead to higher demand for money, higher interest rates, and reduced investment spending, and the foreign price effect, where higher domestic prices make exports less competitive leading to reduced demand for domestic goods.