Why is the aggregate demand curve inversely related to the price level?

The aggregate demand curve is inversely related to the price level primarily due to both the Wealth effect and the Interest Rate effect.

The Wealth effect suggests that when the price level decreases, the real value of money and other assets increases, making consumers feel wealthier. This increase in perceived wealth encourages consumers to increase their spending, thereby boosting overall demand in the economy.

The Interest Rate effect operates by noting that when the price level falls, consumers and businesses need to hold less cash for transactions, which can lead to a decrease in interest rates. Lower interest rates reduce the cost of borrowing, making it cheaper for consumers to take out loans and for businesses to invest in capital. Consequently, increased borrowing stimulates additional spending on consumption and investment, further contributing to higher aggregate demand.

As a result, the combination of these two effects explains why the aggregate demand curve slopes downward: as the price level falls, both consumer spending and investment increase, leading to a rise in the total quantity of goods and services demanded.