Four reasons behind the downward slope to the Aggregate Demand Curve! The price level and aggregate demand are negatively related because of:

List and discuss four “effects”

For example, one of the reasons for the downward slope of the demand curve (that is, the negative relationship between the price level and C + I + G + NX) is the interest rate effect. Demonstrate you understand the interest rate effect by completing the following problems:

A) The opportunity cost of holding money is _____________ .

B) Assume there is a sudden negative supply shock in the economy that lead to a reduction in short run aggregate supply (say a drought, or higher wages throughout the economy). Below, draw a money demand and supply graph to illustrate the effect of the higher price level on the money market (remember, the “price” of money is the interest rate):

Referring to your graph above, outline the three steps that lead from an increase in the price level to a change in aggregate demand (AD):

The higher price level leads to:

ii_______________________________, and

iii. the following change in aggregate demand:________________________________________.

C) What type of spending that is most affected by the lowering of interest rates in the economy? Also state whether the spending is higher or lower as a result of lower interest rates.

D) Investment is an important (and volatile) component of GDP. List 5 specific purchases that would be included as “Investment” when calculating GDP = C + I + G + NX.