Question : The aggregate demand curve slopes downward because of the:

Option 1: Wealth effect
 

Option 2: Interest rate effect
 

Option 3: Foreign trade effect

 

Option 4: All of the above

Correct Answer: All of the above

Solution : The correct answer is (d) All of the above.

The aggregate demand curve slopes downward due to the combined effects of the wealth effect, interest rate effect, and foreign trade effect. These factors contribute to the inverse relationship between the price level (or inflation) and the quantity of goods and services demanded in an economy.

1. Wealth Effect: When the price level decreases, the real value of wealth increases. This leads to a higher level of consumer spending because individuals feel wealthier and can afford more goods and services. As a result, a decrease in the price level leads to an increase in aggregate demand.

2. Interest Rate Effect: A decrease in the price level reduces the demand for money because individuals and businesses need less money to make purchases. This, in turn, leads to a decrease in interest rates. Lower interest rates encourage borrowing and investment, which stimulates aggregate demand.

3. Foreign Trade Effect: A decrease in the price level makes domestic goods and services relatively cheaper compared to foreign goods and services. This leads to an increase in exports and a decrease in imports. The net effect is an increase in aggregate demand.

These three effects work together to create a downward-sloping aggregate demand curve. As the price level decreases, consumers' wealth increases, interest rates decline, and the country's goods become more competitive in international markets. These factors lead to higher levels of consumer spending, investment, and net exports, resulting in an increase in aggregate demand.