Adding the risk premium to the AS/AD model is represented by a downward movement along the AD curve.

Question

Quizplus · Accepted Answer

Adding the risk premium to the AS/AD model would shift the AD curve downwards, not movement along the curve. The risk premium reflects the extra return investors demand for holding risky assets, which increases the cost of borrowing and reduces investment spending, reducing aggregate demand. Therefore, the AD curve would shift downwards to represent the lower level of real GDP and price level.

Adding the Risk Premium to the AS/AD Model Is Represented