Final answer:
The interest-rate and real-balances effects explain the shape of the aggregate demand curve, with changes in interest rates affecting borrowing, spending, and investment, which then leads to shifts in the curve.
Step-by-step explanation:
The interest-rate and real-balances effects are important because they help explain the shape of the aggregate demand curve. An increase in interest rates, as governed by policy tools like those used by the Federal Reserve, tends to discourage borrowing. This, in turn, reduces household spending on big-ticket items and business investments, causing a shift in the aggregate demand curve. Conversely, lower interest rates stimulate consumption and investment, leading to a rightward shift in the aggregate demand curve. Additionally, interest rates can influence exchange rates, which affects the export and import components of aggregate demand. The aggregate demand curve is therefore downward sloping owing to the interest-rate effect where higher interest rates reduce demand and the real-balances effect where increased price levels reduce the purchasing power of money.