Chapter-10 Answers
1) The aggregate demand curve is downward-sloping because of the real-balances effect, foreignpurchases effect, and interest-rate effect. The real-balances effect states that, as price level
rises, the real value of people’s monetary assets declines. Since people are now less wealthy,
they demand a lesser quantity of real GDP. The foreign-purchases effect states that, as the price
level rises, foreigners are able to afford fewer of our goods, which also lowers the quantity of
real GDP demanded. Lastly, the interest-rate effect says that an increase in price level causes a
decrease in the real money supply. This leads to an increase in interest rates, a decrease in the
amount of investment, and thus a decrease in the amount of real GDP demanded. These are
different from the reasons the single-product demand curve has a negative slope. That slope is
caused by diminishing marginal utility, the income effect, and the substitution effect.
The multiplier causes the aggregate demand curve to shift further than it would from an initial
injection. After an injection, some money continues to circulate, the amount of which depends
upon the multiplier.
2) The real-balances effect states that, if the price level rises, the real value of people’s money,
savings accounts, and so on declines. Since people are now less wealthy, they can demand a
lesser quantity of real GDP. On the other hand, the wealth effect states that, if people’s assets
increase in value while the price level stays constant, people become more wealthy. This causes
people to demand a greater amount of real GDP at each price level and thus results in a
rightward shift of the demand curve.