CFA Practice Question

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CFA Practice Question

Which of the following is (are) NOT a reason why the aggregate demand curve is downward-sloping?

I. When the price level rises, the real wealth of consumers decreases, and thus consumers buy less.
II. When the price level rises, interest rates tend to rise, decreasing the quantity of investment.
III. When the price level rises, consumers will substitute other less-expensive goods, and the quantity demanded will fall.
IV. When the price level rises, domestic goods become more expensive relative to foreign goods, and thus exports fall and imports rise.
Correct Answer: III only

Unlike demand in a single market, aggregate demand is not downward-sloping due to substitution effects. Aggregate demand is a relationship between average prices and ALL output, and thus this sort of substitution effect is not possible.

User Contributed Comments 6

User Comment
danlan For B, when the price level rises, interest rate tend to rise in order to prevent inflation, so investment becomes less.
HermanL there's a causal relationship between price level and interest rates rising. I wish I could draw a graph, but intuitively as price level rises *real* money supply goes down, so for the same level of output Y, the money-market clearing level of interest rate (in the money markets of the LM curve) is higher (same demand, less supply) b/c ppl are willing to pay a higher interest for money.

Interest rate, then, in this case, can be thought of as the price of money.
emy1 going through these study notes is so helpful...I was so lost with the CFA text notes must be the bulkyness..I guess one tends to zone out at some point..
ankurwa10 I think these notes are perfect for revision. Otherwise CFAI text is too much (given the time frames and jobs most of us have)
FozzeyBear speak for yourself ankurwa10, I'm unemployed
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