Question

1. Prepare a concept map which presents a description of:
    a. Aggregate demand
    b. Aggregate Demand Curve
    c. The 3 effects that explain the decreasing slope of the aggregate demand curve

Answer 1

1. Short run aggregate demand curve shows the relationship between price level and quantity of real GDP demanded by households, firms and government, holding everything else constant.

AD = C + I + G + (X-M)

The components of AD are consumption by households, investment by businesses, government spending and investment and net exports (exports minus imports).

2. Short run aggregate supply (SRAS) curve shows the relationship between price level and real GDP supplied by firms. SRAS is upward sloping.

3. The AD curve is downward sloping because of:

1. The interest rate effect. When AD increases, there is increase in AD for money supply and this pushes up the interest rate.
2. The second reason is the real balances effect. When price-levels rise, the purchasing power of money falls and value of financial assets and other wealth held by the population falls.
3. The international trade effect: As the price level in the home country rises relative to other countries, consumers in the home country will buy goods from abroad in preference to their own home-produced goods. At the same time foreigners will find home country’s goods more expensive and will decrease their purchase.