宏观经济学问题（英语）1,Explain why the aggregate-demand curve is downw

1. Three explanations for the negative slope are:
a. Interest rate effect
b. Real balance effect
c. Foreign purchases effect

Aggregate demand (AD) is a curve showing the total amount of goods and services (real GDP) that will be purchased at different price levels.

a. Interest rate effect:
As price level (P) rises, the real money supply (=nominal money supply/P) falls. This leads to an increase in interest rate. As interest rate rises, investment spending falls because of the increased cost of borrowing to finance investment. As investment falls, aggregate expenditure (AE) falls, in turn leading to a fall in real GDP (or Y). (Hence we see as P increases, Y decreases.)

Try picturing this in terms of the IS-LM model too. The fall in the real money supply, which leads to an increase in interest rate, causes the LM curve to shift leftwards. Along an unchanged downward sloping IS curve, this results in a fall in equilibrium real GDP because of an upward movement** along the IS curve (**we say upward movement because as interest rate rises, investment spending falls, AE falls and hence real GDP falls). This confirms our conclusion that a rise in P leads to a fall in real GDP.
NOTE: The interest rate effect is by far the dominant reason for a downward sloping AD curve.

b. Real balance effect (also known as real wealth effect or real money balances effect):
It operates through consumption. As price level rises, purchasing power of money balances falls. As our real wealth falls, we will cut back on our consumption spending; hence autonomous consumption (Co) falls. This results in a decrease in AE and hence a decrease in real GDP.

We can also picture this in terms of the IS-LM model. The fall in AE leading to a decrease in real GDP occurs at an assumed unchanged interest rate. This shifts the IS curve leftwards from IS(0) to IS(1). With an unchanged upward sloping LM curve, the fall in real GDP lowers transactions demand for money and hence total money demand (which comprises both transactions demand and asset demand components). This in turn lowers interest rate (that is, a downward movement along the LM curve). As interest rate falls, we know that investment spending will rise and hence AE and real GDP will rise (that is, a downward movement along IS(1)). [Of course, this rise in real GDP is not enough to offset the original fall in real GDP because to the downward sloping nature of the LM curve.] This ensures attainment towards simultaneous equilibrium in money market and output market. Overall, we trace that a rise in P leads to a fall in Co, AE, and hence Y.

c. Foreign purchases effect:
It is applicable only to open economies with foreign trade being introduced into our explanation. With an increase in domestic price level relative to those of trading partners, domestic consumers will spend less on domestically produced goods and services and more on imports (M). Also, foreigners will buy less of our exports (X). The increase in M and decrease in X (that is, a decrease in net exports) means a decrease in real GDP.

In terms of our IS-LM model, the decrease in net exports causes a fall in AE, a fall in real GDP and hence a leftward shift in the IS curve. With an unchanged LM curve, we notice an overall fall in both interest rate and real GDP (as we have explained in our "real balance effect"). It is conclusive that a rise in P leads to a fall in Y.

Ref: http://answers.yahoo.com/question/index?qid=20070713193824AASdcb1
2. The sticky-wage model of the upward sloping short run aggregate supply curve is based on the labor market. In many industries, short run wages are set by contracts. That is, workers are paid based on relatively permanent pay schedules that are decided upon by management or unions or both. When the economy changes, the wage the workers receive cannot adjust immediately.

Given that wages are sticky, the chain of events leading from an increase in the price level to an increase in output is fairly straightforward. When the price level rises, the nominal wage remains fixed because this is solely based on the dollar amount of the wage. The real wage, on the other hand, falls because this is based on the purchasing power of the wage. A higher price level means that a given wage is able to purchase fewer goods and services.

PARAGAPH When the real wage that firms pay employees falls, labor becomes cheaper. However, since the amount of output produced for each unit of labor is still the same, firms choose to hire more workers and increase revenues and profits. When firms hire more labor, output increases. Thus, when the price level rises, output increases because of sticky wages.

Let's summarize the chain of events that leads from an increase in the price level to an increase in output in the sticky-wage model. When the price level rises, real wages fall. When real wages fall, labor becomes cheaper. When labor becomes cheaper, firms hire more labor. When firms hire more labor, output increases.
Ref:http://www.***.com/economics/macro/aggregatesupply/section2.rhtml
3. The worker-misperception model of the upward sloping short- run aggregate supply curve is again based on the labor market. This time, unlike in the sticky-wage model, wages are free to move as the economy changes. The amount of work that an employee is willing to supply is based on the expected real wage. That is, workers know how many dollars they are being paid, the nominal wage, but workers can only guess at how much goods and services they can purchase with this wage, the real wage. In general, the higher the real wage, the more work that workers are willing to supply.

Now let's say that the price level increases. Because we assume that firms have more information than workers do, firms will give workers a raise so that their nominal wage increases with the price level. But since the workers do not realize that the price level increased, they will believe that their real wage increased, not just their nominal wage. At a higher real wage, workers are induced to work more. When workers work more, output increases. Thus, when the price level increases, output also increases because of worker-misperception.

Let's summarize the chain of events that leads from an increase in the price level to an increase in output in the worker-misperception model. When the price level rises, firms increase nominal wages. When nominal wages increase, workers--due to misperceptions--believe that real wages also increase. When workers believe that real wages increase, workers provide more labor. When workers provide more labor, output increases.

Ref:http://www.***.com/economics/macro/aggregatesupply/section2.rhtml

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