Question

1) List and explain the three reasons the aggregate-demand curve is downward sloping. 2) Explain why the long-run aggregate-supply curve is vertical. 3) What causes aggregate demand to shift to the left and what causes an aggregate demand to shift to the right? Give one example for each scenario. 4) Explain why economic fluctuate in the short term and contrast short-term and long-term economic performance. 5) How can we use the aggregate demand and supply models to study the sources of inflation?

Answer 1

1):-There are three reason for the downward sloping aggregate demand curve they are namely the pigou's wealth effect , keynes interest rate effect, and mundell- flaming exchange rate effect no doubt they are different in nature yet they work together.

Explaination

•The first reason for downward sloping aggregate demand curve is pigou's wealth . At the given amount for currency a lower price level provide more purchasing power .

•When price level fall , consumer are wealthier and provide more chance of spending thus low price level induce customer to spend more and that increase the aggregate demand.

•Second one is Keynes interest rate effect interest rate move in same level as inflation.

•Lower inflation clearly means that lender required lower compensation in the form of interest.

•Lower interest increase the demand for investment because investment falls with the interest rate.

•So fall in price level decrease interest rate which lead to increase in investment demand and this cause in increase in aggregate demand.

•Mundell - Fleming's exchange rate effect is third reason as a decrease in inflation rate cause increaseing in net export because of cheap availability of domestic good and services . Increase in net export increase net aggregate demand because net export is part of aggregate demand so fall in Price level increase net export and increase in net export cause in increase of aggregate demand.

2):-The long run aggregate-supply curve is vertical because inflation rate doesn't not effect the Long run determinant of real GDP that consist natural resources, capital and supplies of labor .

•It is an application of classical Dictonomy and monetary neutrality.