Why is demand downward sloping

The third reason for the downward slope of the aggregate demand curve is Mundell-Fleming's exchange-rate effect. Recall that as the price level falls the interest rate also tends to fall. When the domestic interest rate is low relative to interest rates available in foreign countries, domestic investors tend to invest in foreign countries where return on investments is higher.

As domestic currency flows to foreign countries, the real exchange rate decreases because the international supply of dollars increases. A decrease in the real exchange rate has the effect of increasing net exports because domestic goods and services are relatively cheaper. Finally, an increase in net exports increases aggregate demand, as net exports is a component of aggregate demand.

Thus, as the price level drops, interest rates fall, domestic investment in foreign countries increases, the real exchange rate depreciates, net exports increases, and aggregate demand increases. There is another major model that is useful for explaining the nature of the aggregate demand curve.

This model is called the IS-LM model after the two curves that are involved in the model. The IS-LM model exists in a plane with r, the interest rate, on the vertical axis and Y, being both income and output, on the horizontal axis. The IS-LM model has the same horizontal axis as the aggregate demand curve, but a different vertical axis. Under the terms of the licence agreement, an individual user may print out a PDF of a single entry from a reference work in OR for personal use for details see Privacy Policy and Legal Notice.

Oxford Reference. Publications Pages Publications Pages. Recently viewed 0 Save Search. Your current browser may not support copying via this button. Subscriber sign in You could not be signed in, please check and try again. Username Please enter your Username. A number of them are as follows:. Causes of the downward slope of the demand curve Law of demand. Substitution effect.

Earnings impact. New consumers. Antique consumers. The law of demand states that with ever-increasing amounts of the commodity, its demand declines. As an example, whilst someone is hungry, the first chapati that he eats will provide him with the most pride. As he's going to eat chapatis, his degree of satisfaction will diminish. For this reason, whilst the amount of goods is greater, the demand for the commodity is less. As a result, the customer isn't always inclined to pay a greater rate for the commodity and its demand will decline.

Ordinary people buy more when price falls and less when price rises. The rich do not have any effect on the demand curve because they are capable of buying the same quantity even at a higher price. There are different uses of certain commodities and services that are responsible for the negative slope of the demand curve.

With the increase in the price of such products, they will be used only for more important uses and their demand will fall.

On the contrary, with the fall in price, they will be put to various uses and their demand will rise. For instance, with the increase in the electricity charges, power will be used primarily for domestic lighting, but if the charges are reduced, people will use power for cooking, fans, heaters, etc.

There is a tendency to satisfy unsatisfied wants. Each person has some unsatisfied wants. When the price of a good such as apple falls, he wants to satisfy his unsatisfied wants which leads him to increase its demand.

Because of this tendency of human beings, the demand curve slopes downwards to the right. Article Shared by. Related Articles. Changes in Demand: 2 Ways. Uncertainty, Risk and Probability Analysis.

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