AD Curve Transmission Mechanisms

Why does the Aggregate Demand (AD) curve slope downwards?

Due to the inverse relationship between Price Level and Real GDP (Y).

What is the primary impact of the Wealth Effect?

A fall in price level increases real purchasing power.

How does the Wealth Effect influence household consumption (C)?

Increased real income and asset value raise consumer spending.

Define the Trade Effect in the context of falling prices.

Domestic exports become relatively cheaper and more competitive.

How do domestic consumers react to falling prices under the Trade Effect?

They switch from foreign imports to cheaper domestic goods.

What is the net result of the Trade Effect on AD?

Net exports (X−M) increase.

What triggers the Interest Rate Effect?

A fall in the price level or inflation rate.

How does the Bank of England react to low inflation targets?

The central bank lowers official interest rates.

How do lower interest rates impact firm behavior?

Lower borrowing costs incentivize capital investment (I).

How do lower interest rates affect consumer behavior?

They incentivize consumer borrowing and spending (C).

What is the effect of lower interest rates on the exchange rate?

Capital outflows cause the exchange rate to weaken.

Which components of AD are boosted by the Interest Rate Effect?

Consumption (C), Investment (I), and Net Exports (X−M).

What does an 'extension along the AD curve' signify?

An increase in Real GDP (Y) due to a lower price level.

What happens to the real value of assets when the price level falls?

The real purchasing power of assets increases.

Summarize the end result of all three transmission mechanisms.

A fall in price level leads to an increase in Real GDP (Y).