Chapter 13, Problem 1RQ

To determine

The variables related to the aggregate demand curve and determinants of its slope.

Explanation of Solution

The aggregate demand curve shows the quantity demand or short-run equilibrium output at different price levels or inflation rate. If holding all else constant, an increase in rate of inflation reduces the planned consumption, investment and net export. This inverse relation between the inflation rate and the output level causes a downward sloping aggregate demand curve.

A fall in household wealth and thereby the planned consumption due to an increase in inflation is referred to as the wealth effect. An increase in rate of interest due to a higher inflation is referred to as interest rate effect. Whereas, an appreciation in the U.S. dollar and a corresponding reduction in the level of export, due to a higher rate of inflation is considered as the exchange rate effect. Both these effects reduce the planned consumption and planned investment and thereby the short-run output.

Economics Concept Introduction

Aggregate demand curve: The aggregate demand curve shows the quantity demand at different price levels.