ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -Definition: The wealth effect of a change in the aggregate price level is the effect on consumer spending caused by the effect of a change in the aggregate price level on the purchasing power of consumers’ assets.

Detailed explanation-2: -An increase in wealth will induce people to increase their consumption. The consumption component of aggregate demand will thus be greater at lower price levels than at higher price levels.

Detailed explanation-3: -The Wealth Effect: This says that a rise in the price level will make people who have money and other financial assets feel poorer. They then buy less, and the opposite is true if the price level were to fall-people would buy more.

Detailed explanation-4: -When the price level falls, consumers are wealthier, a condition which induces more consumer spending. Thus, a drop in the price level induces consumers to spend more, thereby increasing the aggregate demand. The second reason for the downward slope of the aggregate demand curve is Keynes’s interest-rate effect.