AS/AD curve recap worksheet

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Downward Sloping Aggregate Demand Curve [CHECK ANSWERS]

1) Explain how Aggregate Demand is different from a demand curve.

Demand is microeconomics concept whole agreegate demand is macroeconomics concept. Demand means different levels of demand at different prices for a particular product. Aggregate demand means demand of all goods and services produced in a economy in giving year.

Suggested Answer: A demand curveshows the relationship between quantity demanded and price for one product. AD is the relationship between price level, average of all prices, and the level of production in the economy, Real GDP. While demand looks at one product at a micro level, AD looks at all prodcuts and markets at the macro level.

2) Explain why a lower price level is likely to result in more consumption spending and therefore more real GDP.

Aggregate demand can be calculated using the equation [AD = C + I + G + (X-M)]. At a lower price level consumers are more willing and able to pruchase the good (becomes more affordable). This increases consumer spending (C). Therefore, according to the equation, AD must increase in order to remain true. This results in greater output, or in other words, GDP.

Suggested Answer: The Wealth Effect - Th elower price level increases the purchasinf pwoer of consumers. They will be able to purchase more goods and services, so consumption goods and services will increase, so Real GDP will be higher (remember Real GDP can be measured as expenditure an be measured as expendie on goods and services).

3) Explain the relationship between price level and interest rates.

High price levels equate to lower interest rates. This occurs because consumers become less willing and able to purchase the good/service (less affordable). Instead they will redirect these funds to savings. This increase the money supply (amount available to be lent). As a result the cost of borrowing decrease, or in otherwords, interest rates decrease.

Suggested Answer: The lower price means the households will have more capacity to save. The increased savings menas that more to encourage firms to borrow more.

4) Explain why lower interest rates rease investment spending and therefore real GDP.

The cost of borrowing has decreased, therefore providing incentive for producers to borrow the necessary funds to invest (e.g. in captial). As per the equation, when investment increase (I), AD must increase. Therefore real GDP increase.

Suggested Answer: The lower interest rates will make investment more profitable, increasing expedature on capital goods and services, so GDP increases.

5) Explain the relationship between interest rates and the exchange rate effect.

Suggested Answer: