Open with * 3 Macroeconomics ACTIVITY 3-1 An Introduction to Aggregate Demand Why Is the Aggregate Demand Curve Downward Sloping? Aggregate demand (AD) shows the relationship between real gross domestic product (GDP) and the price level in the economy. As shown in Figure 3-1.1, the AD curve has a negative slope, showing that as the price level increases, real GDP decreases, and as the price level decreases, real GDP increases. The negative relationship between the price level and real GDP is explained by three different things that happen when the price level changes in the economy. When the price level changes, it affects consumers' purchasing power, interest rates paid by consumers and businesses, and the relative prices of domestic goods and services compared to imported goods and services. The effect of a change in the price level on consumers' purchasing power is called the wealth effect. The effect of a change in the price level on interest rates (and therefore interest- sensitive spending by consumers on things like houses and cars and investment spending by businesses) is called the interest rate effect. The effect of a change in the price level on imports and exports is called the net export effect. These three effects explain why the AD curve has a negative slope. Student Alert: Make sure that when you label an AS/AD graph you use price level and real GDP. Don't use P and Q-those are MICRO labels! Figure 3-1.1 Aggregate Demand Curve PRICE LEVEL AD REAL GDP