Principles of Economics
7th Edition
ISBN: 9781305156043
Author: N. Gregory Mankiw
Publisher: Cengage Learning US
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Question
Chapter 34, Problem 1QR
To determine
Liquidity preference theory and downward sloping of aggregate demand.
Expert Solution & Answer
Explanation of Solution
Keynes in his classic book “The General Theory of Employment, Interest, and Money”, proposed the theory of liquidity preference, according to which, the interest rate adjusts to bring money supply and money demanded into balance. In other words, it is the theory of how the interest rate is determined.
According to the theory, the aggregate–demand curve slopes downward because
- (1) An increase in price level raises money demand.
- (2) Higher money demand causes the interest rate to rise.
- (3) A rise in interest rate reduces the quantity of goods and services demanded.
Thus, there exists an inverse relationship between the price level and aggregate demand, making the AD curve slopes downward.
Economics Concept Introduction
Concept introduction:
Aggregate demand (AD): Aggregate demand refers to the total value of the goods and services that are demanded at a particular price in a given period.
Money supply: Money supply refers to the total amount of monetary assets circulating in an economy during a particular period.
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