Why the AD Curve Slopes Downward

Students will be able to list the reasons why the Aggregate Demand curve is downward sloping and explain why there is an inverse relationship between price level and GDP.

This activity is appropriate for a Principles of Macroeconomics course. It is most likely too advanced for a Survey of Economics course. It could be used in an Intermediate Macroeconomics course.
Prior to engaging in this activity, students should understand the AD/AS model. This activity is very useful to help students review the model.
There is no class size limitation.
This activity can be done in one class period. It should take about 30 minutes.

Overview

This activity is intended to help students understand the three effects that contribute to the downward slope of the Aggregate Demand curve. They will be asked to put the factors that contribute to each effect into a logical sequence to show an inverse relationship between price level and GDP. This will help them to use reasoning to understand these effects instead of merely memorizing the sequence. While there is only one correct answer for each effect, it does allow students to debate the sequence of events in their groups and adds to their understanding of the AD curve.

The main activity allows students to decide which reason is most likely to be the weakest link in the sequence. That is, they will debate which of the three reasons is most likely not to occur in real life based on how people and firms actually think and behave.

Expected Student Learning Outcomes

Students will be able to list the reasons why the Aggregate Demand curve is downward sloping and explain why there is an inverse relationship between price level and GDP.

Information Given to Students

Having created the sequence of events for each of the three effects, students are asked the following:

Which of the three effects does your group think is the weakest link in the sequence of events you just created? In other words, which is most likely to not occur in the real world? Please explain your reasoning for your answer.

A. The Wealth Effect may not occur because not all people will feel richer and those that do may not increase their consumption.
B. The Interest Rate Effect may not occur because lower interest rates may not cause more investment to occur.
C. The International Effect may not occur because lower export prices may not lead to more exports being sold.

Instructors should emphasize that students should use reasoning, not memorization, to understand and explain the reasons why the AD curve slopes downward.

Instructions for the Main Activity

In the main activity, students will debate which of the three effects are most likely to fail. Even though economic theory tells us that these are the reasons that the AD curve is downward sloping, the sequence of events may not occur as exactly as theory states. The instructor should be prepared to summarize by leading a discussion over why each of the three effects may fail in the real world. The following will provide the instructor with some guidance.

The Money Wealth Effect may fail since people at different income levels have different marginal propensities to consume. Additionally, even among people at the same income level, some will tend to spend more while others will be more likely to use this additional money to pay down debt or add to their savings. And depending on what is occurring in the economy and in their lives, peoples' desire to save versus spend will change over time.

The Investment Effect may fail because interest rates are not the only thing that businesses consider when deciding whether to invest and expand production. They also look at economic indicators, such as the business cycle, consumer confidence, and the unemployment rate, to determine what they think consumers will do in the future. They are less likely to utilize lower interest rates to invest if the economy is facing a severe recession.

The International Effect may fail since people in other countries may decide not to purchase our exports due to better options in other countries or due to the state of their economy. For example, if a country in Europe goes into recession, those citizens may not buy more American exports as they will have less aggregate income to spend.

Instructions for Pre-Activity

Begin the activity by handing out packets of slips of paper to each student group.
Each slip of paper has a different event on it. The packets should have the slips of paper mixed up. 
1. Ask students to identify the names of the three effects that describe why the AD curve is downward sloping. (These effects are what they will be working on.) The effects are called the money wealth effect, the interest rate effect, and the international effect. (However, different textbooks may have different names for them so use the ones that correspond to the textbook you are using.)
2. Students are asked to place the slips of paper in a logical sequence of events that comprise each of the three effects that contribute to the shape of the AD curve. For each effect, they are asked to start with a decrease in the price level and end with an increase in AD and GDP and explain what causes the inverse relationship.

The slips of paper should be created as follows:

Price level declines – 3 slips
Goods are cheaper – 3 slips
Exports are cheaper -1 slip
Exports increase – 1 slip
AD increases – 3 slips
Y or GDP increases – 3 slips
People have more money after purchasing goods – 1 slip
People increase savings – 1 slip
More savings reduces interest rates – 1 slip
Investment increases – 1 slip
People feel richer – 1 slip
Consumption increases – 1 slip

This activity is assessed through the discussion of the students' answers. It could be turned into an essay or short answer question on an exam or quiz.