What is the difference in the explanation of the shape of the aggregate demand curve and a single product demand curve? After all, both demand curves show an inverse relationship between price and quantity.
What will be an ideal response?
The aggregate demand curve shows an inverse relationship between the price level (the general level of all prices) and real domestic output (the equilibrium quantity of all products). The explanation of this inverse relationship is based on the real-balances effect, the interest-rate effect, and the foreign-purchases effect. In this case, as the price level rises, the quantity of real domestic output decreases.
The supply and demand model for a particular product shows an inverse relationship between the price of that product and the quantity of that product. The explanation for the inverse relationship between price and quantity in the demand for a single product is based on the substitution and income effects. The substitution effect is not applicable to the aggregate case because there is no substitute for all products in the economy. Also, the income effect is not applicable to the aggregate case because income now varies with aggregate output.