Question

Describe whether the following changes cause the aggregate demand curve to increase, decrease, or neither.

price level increases

Answer 1

In macroeconomics, a decrease in the aggregate price level does not increase aggregate demand for the same reason as in microeconomics. Instead, factors such as the real wealth effect, interest rate effect, and international trade effect contribute to an increase in total spending and aggregate demand.

Step-by-step explanation:

In microeconomics, a decrease in price causes an increase in quantity demanded because the product becomes relatively less expensive compared to substitute products. However, in macroeconomics, when the aggregate price level decreases, it does not directly result in an increase in aggregate demand for the same reason.

In macroeconomics, aggregate demand is determined by factors such as consumption, investment, government spending, and net exports. When the aggregate price level decreases, it can lead to an increase in aggregate demand through various channels:

1. Real Wealth Effect: A decrease in the aggregate price level increases the purchasing power of consumers' money holdings, which leads to an increase in consumption and overall spending.
2. Interest Rate Effect: A decrease in the aggregate price level reduces the demand for money, which then lowers interest rates. Lower interest rates encourage investment and borrowing, leading to an increase in aggregate demand.
3. International Trade Effect: A decrease in the aggregate price level makes domestic goods relatively cheaper compared to foreign goods. This increases net exports, leading to an increase in aggregate demand.

These factors collectively contribute to an increase in total spending and, therefore, aggregate demand, even though individual goods may not become cheaper.