The wealth effect along an aggregate-demand curve stems from the idea that a higher price level:

• A. encourages firms to invest more due to higher profits
• B. reduces the real value of household wealth, leading to lower consumer spending
• C. increases the purchasing power of money, leading to higher consumer spending
• D. causes the government to increase its spending to offset inflation

Answer: (B)

Verified step by step guidance

1. Understand the concept of the wealth effect in macroeconomics: it refers to how changes in the price level affect the real value of household wealth and consequently consumer spending.
2. Recall that the aggregate demand curve shows the relationship between the overall price level and the quantity of goods and services demanded in the economy.
3. Recognize that when the price level rises, the real value of money and other nominal assets held by households decreases because their purchasing power falls.
4. Connect this decrease in real wealth to a reduction in consumer spending, since households feel less wealthy and thus tend to spend less.
5. Conclude that the wealth effect causes a movement along the aggregate demand curve where a higher price level leads to lower consumer spending due to the reduced real value of household wealth.