downward sloping aggregate demand curve

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Figure %: Graph that the accumulation demand curve.The most noticeable function of the accumulation demand curve is that it is bottom sloping, as viewed in . There are a number of reasons because that this relationship. Recall the a bottom sloping accumulation demand curve means that together the price level drops, the quantity of calculation demanded increases. Similarly, together the price level drops, the national revenue increases. There space three an easy reasons because that the downward sloping aggregate demand curve. These space Pigou"s riches effect, Keynes"s interest-rate effect, and Mundell-Fleming"s exchange-rate effect. These three factors for the downward sloping accumulation demand curve space distinct, however they job-related together.

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The first reason because that the bottom slope that the aggregate demand curve is Pigou"s wide range effect. Recall that the nominal value of money is fixed, yet the real value is dependent ~ above the price level. This is because for a given amount the money, a lower price level provides much more purchasing strength per unit of currency. Once the price level falls, consumers are wealthier, a problem which induces more consumer spending. Thus, a autumn in the price level induces consumers to invest more, thereby raising the accumulation demand.

The 2nd reason because that the bottom slope of the accumulation demand curve is Keynes"s interest-rate effect. Recall that the amount of money demanded is dependent upon the price level. The is, a high price level method that the takes a relatively huge amount of currency to make purchases. Thus, consumers demand big quantities of currency when the price level is high. When the price level is low, consumers demand a relatively small amount of currency since it bring away a fairly small amount of currency to make purchases. Thus, consumers save larger amounts of money in the bank. Together the lot of currency in banks increases, the supply of loans increases. Together the supply of loan increases, the cost of loans--that is, the interest rate--decreases. Thus, a low price level induces consumers to save, which subsequently drives under the attention rate. A low attention rate increases the demand for investment as the price of investment falls with the attention rate. Thus, a fall in the price level to reduce the interest rate, which increases the demand for investment and thereby increases aggregate demand.

The third reason for the bottom slope that the accumulation demand curve is Mundell-Fleming"s exchange-rate effect. Remind that together the price level drops the attention rate also tends come fall. When the residential interest rate is low relative to interest rates accessible in international countries, residential investors tend to invest in foreign countries where return on invest is higher. As domestic currency flows to foreign countries, the genuine exchange rate decreases because the global supply that dollars increases. A diminish in the real exchange rate has actually the effect of enhancing net exports since domestic goods and also services are fairly cheaper. Finally, rise in net exports increases accumulation demand, together net exports is a component of accumulation demand. Thus, as the price level drops, interest prices fall, domestic investment in foreign countries increases, the actual exchange price depreciates, network exports increases, and aggregate demand increases.

IS-LM model of aggregate demand

There is another major model that is useful for explaining the nature of the accumulation demand curve. This version is referred to as the IS-LM version after the two curves the are affiliated in the model. The IS curve explains equilibrium in the industry for goods and services where Y = C(Y - T) + I(r) + G and the LM curve explains equilibrium in the money sector where M/P = L(r,Y). The IS-LM version exists in a airplane with r, the interest rate, on the upright axis and also Y, being both income and output, ~ above the horizontal axis. The IS-LM model has actually the same horizontal axis as the aggregate demand curve, yet a various vertical axis.

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Figure %: Graph of the IS-LM curves.

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The IS curve explains equilibrium in the market for goods and also services in regards to r and Y. The IS curve is bottom sloping because as the interest price falls, investment increases, thus increasing output. The LM curve explains equilibrium in the industry for money. The LM curve is increase sloping because greater income results in greater demand because that money, hence resulting in higher interest rates. The intersection the the IS curve v the LM curve reflects the equilibrium interest rate and price level.