Question

True or False. Decreases in AD normally lead to decreases in both output and the price level.

Short answer

The statement is true.

Step-by-step solution

Meaning and shifts in the aggregate demand curve

An aggregate demand curve represents price level at different levels of the real output, which the consumers are willing to pay collectively in the economy. The aggregate demand for an open public economy comprises private consumption, gross investment, government expenditure, and net exports.

The aggregate demand is estimated by what the consumers are paying at the given output level in the economy. A change in any of the components of the aggregate demand causes an overall shift in aggregate demand.

Reason for the true statement

As the aggregate demand decreases, the aggregate demand curve shifts from AD to the left (AD’) along the constant supply curve AS. Thus, the economy’s equilibrium shifts from e to e’ along the AS curve.

At the initial equilibrium e, the price level is P, and the real output is Y. As the equilibrium shifts to the left, the price comes down to P’, and the output reduces to Y’.