Wealth Effect on Aggregate Demand

Steps:

• Recall that aggregate demand (AD) slopes downward because lower price levels increase real purchasing power.
• Identify explanations like wealth, interest rate, and international effects.
• Evaluate options against these: A involves imports (trade effect), B links prices to interest rates (interest rate effect), C mentions productivity (supply-side), D addresses asset values (wealth effect).
• Select D as it directly explains increased consumption from higher real wealth at lower prices.

Why D is correct:

• The wealth effect states that a lower price level raises the real value of money holdings and assets, boosting household wealth and thus consumption spending, per the AD equation Y = C + I + G + (X - M).

Why the others are wrong:

• A: Lower prices reduce import demand via exchange rate appreciation, but the option incorrectly states a rise in imports.
• B: High prices raise interest rates, curbing consumption, but the option reverses the causal direction.
• C: Productivity affects aggregate supply, not demand, by shifting the AS curve.

Final answer: D