Interest Rate Effect on Aggregate Demand

Steps:

• Aggregate demand slopes downward because a lower price level boosts real money supply.
• This increases the real value of money holdings, as purchasing power rises.
• Higher real balances lower interest rates via the money market equilibrium.
• Lower interest rates stimulate investment and consumption, raising quantity demanded.

Why B is correct:

• Reduction in price level increases real money balances (M/P rises), per the quantity theory of money, encouraging spending.

Why the others are wrong:

• A: Lower prices improve, not decline, international competitiveness by making exports cheaper.
• C: Real balances rise, decreasing interest rates, not increasing them.
• D: Expectations of falls might delay purchases, reducing demand, opposite of the slope reason.

Final answer: B