The foreign purchases, interest rate, and real-balances effects explain why the
A) aggregate demand curve is downward sloping.
B) aggregate demand curve may shift to the left or right.
C) economy will adjust toward equilibrium.
D) aggregate expenditures schedule may shift up or down.

Question

Quizplus · Accepted Answer

The foreign purchases effect states that as the domestic price level increases relative to foreign price levels, net exports decrease, which reduces aggregate demand. The interest rate effect states that as the price level increases, individuals and firms need more money to finance purchases, which drives up the demand for money and interest rates, thus reducing consumption and investment spending, and decreasing aggregate demand. The real-balances effect states that as prices increase, the real value of money decreases, reducing the purchasing power of consumers and firms, leading to a decrease in consumption and investment spending, and hence a decrease in aggregate demand. These three effects together explain why the aggregate demand curve is downward sloping.

The Foreign Purchases, Interest Rate, and Real-Balances Effects Explain Why