Q:

Why does the aggregate demand curve slope downward?

A:

The aggregate demand curve, which illustrates the total amount of goods and services demanded in the economy at a given price level, slopes downward because of the wealth effect, the interest rate effect and the net exports effect, according to CliffsNotes.com. The curve measures the price level on the vertical axis and gross domestic product (GDP) on the horizontal axis.

The aggregate demand curve assumes a constant money supply. When the general price level increases, purchasing power decreases as money is worth less. This causes consumers to reduce their purchases. When the price level decreases, consumers feel wealthier because their money buys more. This inverse relationship between the price level and the total consumption, as measured by GDP, contributes to the downward sloping demand curve.

The interest rate effect also contributes to the downward sloping aggregate demand curve. Given the constant money supply, the increased demand for money results in increased interest rates, which causes the sale of rate-sensitive goods to decline.

The final factor that contributes to the downward sloping aggregate demand curve is the net exports effect. Net exports are the difference between exports and imports. As the general price level increases, imported goods become less expensive relative to domestic goods, causing imports to increase. At the same time, domestic goods become more expensive to foreign buyers, causing exports to decrease. Increasing imports coupled with decreasing exports decrease net exports and contribute to the downward sloping aggregate demand curve.


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