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The following graph shows the aggregate demand (AD) curve in a hypothetical economy. At point A,...


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. 

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As the price level rises, the purchasing power of households' real wealth will _______  causing the quantity of output demanded to _______ .This phenomenon is known as the _______ effect. 


Additionally, as the price level rises, the impact on the domestic interest rate will cause the real value of the dollar to _______ in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore _______ , and the number of foreign products purchased by domestic consumers and firms (imports) will _______ .Net exports will therefore _______ , causing the quantity of domestic output demanded to _______ . This phenomenon is known as the _______ effect.

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Answer #3

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With the increase in the prices, money demand rises, and people started saving by the people increases the rate of interest.

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Answer #1

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As price level rises, purchasing power of household real wealth will decrease, causing the quantity of output demanded to decreases. This phenomenon is known as the income/real effect

As price level rises, real value of dollar to appreciates  in foreign exchange market.

Export will fall and import will rise  Net export will therefore decreases causing the domestic output demand to decrease. This phenomenon is known as the substitution effect.

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Aggregate demand is negatively sloped meaning increase in price leads to decrease in quantity demanded. Interest rate effect and exchange rate effect are the two reasons explaining the slope of aggregate demand.

Blanks :

Decrease, decrease, wealth

Rise, decrease, increase, decrease, decrease, exchange rate

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When the domestic price level falls, foreign goods become relatively more expensive than domestic goods, and domestic goods become relatively less expensive than foreign imported goods. Exports of domestic goods to foreigners therefore rise, while domestic imports of foreign goods fall. Net exports (exports minus imports) therefore rise, leading to a rise in the quantity of domestic output demanded.

The effect of a change in the domestic price level on the quantity of real GDP demanded via its effects on net exports is known as the open economy effect (sometimes referred to as the exchange rate effect).


source: cengage
answered by: Praneeth Sharma Nadimpalli
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