Why the aggregate demand curve slopes downward
The following graph shows the aggregate demand (AD) curve in a hypothetical economy. At point A, the price level is 120, and the quantity of output demanded is $500 billion. Moving up along the aggregate demand curve from point A to point B, the price level rises to 140, and the quantity of output demanded falls to $300 billion.
As the price level rises, the cost of borrowing money will (fall/remain the same/rise), causing the quantity of output demanded to (fall/remain the same/rise).
This phenomenon is known as the (exchange rate/Interest rate/wealth) effect.
Additionally, as the price level rises, the impact on the domestic interest rate will cause the real value of the dollar to (rise/fall) in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore (fall/remain the same/rise), and the number of foreign products purchased by domestic consumers and firms (imports) will (fall/remain the same/rise). Net exports will therefore (fall/remain the same/rise), causing the quantity of domestic output demanded to (fall/remain the same/rise). This phenomenon is known as the (exchange rate/Interest rate/wealth) effect.