Which of the following helps to explain why the aggregate demand curve slopes downward?

• A. The income effect, where higher income leads to increased demand for normal goods.
• B. The wealth effect, where a lower price level increases the real value of money and boosts consumer spending.
• C. The substitution effect, where consumers switch between domestic and foreign goods as prices change.
• D. The law of diminishing marginal utility, which states that additional units of a good provide less additional satisfaction.

Answer: (B)

Verified step by step guidance

1. Understand that the aggregate demand (AD) curve shows the relationship between the overall price level in the economy and the total quantity of goods and services demanded.
2. Recognize that the AD curve slopes downward because as the price level falls, the real value of money increases, making consumers feel wealthier, which encourages more spending. This is known as the wealth effect.
3. Note that the income effect mentioned in the problem refers to changes in demand due to changes in income, but it does not directly explain the downward slope of the AD curve.
4. Understand that the substitution effect typically applies to individual goods and consumer choices between goods, not to the aggregate demand for all goods and services in the economy.
5. Recall that the law of diminishing marginal utility explains consumer behavior for individual goods but does not explain the overall negative relationship between price level and aggregate demand.