The aggregate demand curve slopes downward primarily because of the money – supply effect. Money supply affects the components of aggregate demand. Such as investment, consumption, Govt. Spending, exports etc.
Aggregate demand is downward sloping due to the impact of real money balance. Incase in the price level will reduce the real money balance considering the nominal money constant. This is a tight money situation. Tight money will lead to lower demand due to the increase of interest rate.
We know,Real money balance=(Nominal money balance)/(Price level)
Numerically 100/10tk=10 coke
Real money balance is always express in commodity form. The actual impact of tight money situation in aggregate demand:
Nominal money supply is constant but price level is increase
↑Price level →↓Real money balance →Interest rate ↑→Investment ↓→ output ↓.
Note: Here Interest rate increase for two reason
Scarcity of money
Price of commodity is high.
So it shows that the increase in price decrease the output level.
If price level decrease at constant nominal money supply the condition will be reversing this is known loose money situation.
↓ Price level →↑Real money balance → Interest rate ↓→Investment ↑→ output ↑
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