Macro 2 - quiz 2 Why does the AD curve have a negative...

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quiz 2 Why does the AD curve have a negative slope? The aggregate demand curve shows the real value of purchases at certain prices. The real values of purchases demand on three things: the real-balances effect, the foreign trade effect, and the interest rate effect. The aggregate demand curve has a negative slope because the higher prices get, the lower the demand is. When prices go up, people demand less and less of goods and so their demand for the goods goes down. This occurs with single goods as well as aggregate measures of demand. This works inversely for decreasing prices of goods. If prices start to decrease, people demand more of the good, so their aggregate demand will be higher. You can buy more goods the cheaper the prices are so the aggregate demand is higher. People have more buy- ing power the more money they have because they are wealthier. The richer you are, the less expensive a new dryer may seem compared to someone who is poorer than you. All of a sudden, $100 is nothing to you. It may be the same as $10 to someone who has less money than you. It doesn’t really depend on how much money you have but the lower the prices are because the lower the prices are, the more buying power you have. The lower the price, the more that will be demanded and the more that will be produced so then the prices go up. It’s like a cycle. The foreign trade effect has to do with foreign buyers. If U.S. prices go down, we export more because foreign com- panies are buying more. It also occurs within the country because if our prices are de- creasing, then the more competitive our products get with the foreign products and the more domestically bought products we have. So over-all, we get more money from ex- porting and buying domestically when our prices drop. Once there is more aggregate demand because of the lower prices, we produce more and the price increases, yet again, another cycle. The interest rate effect has to do with domestic borrowing. If things are cheaper, your need to borrow money is lower so banks lower interest rates because they want to sell them. With the lower interest rates, people borrow more and the GDP increases. Why does AS have a positive slope? With aggregate supply, we expect the rate of output to increase when the price level rises. The AS curve is positively sloping because of two effects, the cost effect and the profit effect. With the profit effect, your rate of output will increase when price increases because you will want to sell more at the highest price you can to make more money as a supplier. This produces an upward sloping curve because when price increases, your output will increase because you will want to increase your profit. With the cost effect, as the demand increases, there is also a higher demand for workers because you will want to maximize profits. With the higher demand for workers, the price will increase along with it. As you increase output because of the higher demand, your cost of limited
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This note was uploaded on 11/17/2011 for the course EC 251 taught by Professor Abid during the Summer '10 term at Grand Rapids Community College.

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Macro 2 - quiz 2 Why does the AD curve have a negative...

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