List and describe the three effects that help to explain why the aggregate demand (AD) curve slopes downward
If the AD curve slopes downward, it means that there is an inverse relationship between the price level and the quantity demanded of Real GDP. The three effects that explain this are the real balance effect, the interest rate effect and the international trade effect:
Real balance effect - A decrease in the price level causes purchasing power to rise, which increases monetary wealth. As people become wealthier, they buy more goods and the quantity demanded of Real GDP rises.
Interest rate effect - As the price level falls, a person needs less money to buy the same bundle of goods. As they spend less, people save more and the supply of credit increases. The increased supply of credit leads to falling interest rates, so businesses and households borrow more and buy more goods, resulting in an increase in the quantity demanded of Real GDP.
International trade effect - As the U.S. price level falls, U.S. goods become relatively less expensive and both Americans and foreigners buy more U.S. goods. The quantity demanded of U.S. Real GDP rises.
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