Final answer:
The wealth effect explains why the aggregate demand curve slopes downward, as lower price levels increase households' real wealth and consumption spending, leading to higher aggregate demand.
Step-by-step explanation:
The correct answer to the question regarding the wealth effect in the context of aggregate demand and aggregate supply is A. The wealth effect refers to the idea that when the price level decreases, the real wealth of households increases and as a result consumption spending increases. This effect contributes to the downward slope of the aggregate-demand curve.This effect contributes to the downward slope of the aggregate-demand curve. When the price level decreases, people's savings have a higher purchasing power, which encourages them to spend more on goods and services.
In more detail, the wealth effect suggests that a lower price level increases the purchasing power of consumers' wealth. Consequently, because people feel wealthier, they are more likely to spend, thus increasing consumption. This increase in consumption spending in turn stimulates higher aggregate demand, which is visually represented by the downward slope of the aggregate demand curve. The wealth effect is an essential factor that explains why the aggregate demand curve has a negative slope.