How Would a Reduction in Interest Rates at Each Price Level Affect Aggregate Demand or SR Aggregate Supply?

Question by dreamlikealice: How would a reduction in interest rates at each price level affect aggregate demand or SR aggregate supply?
The ANSWER is Aggregate Demand shifts RIGHT, which, I thought, means that people plan to spend more .. but why would people plan to spend more if interest rates had dropped? Doesnt Price Level drop is interest rates drop? Thus things are less expensive and people will plan to spend less?

Can someone explain? Thanks so much!

Best answer:

Answer by JNS
You are correct except for one important point. Yes–when interest rates go down, people save less (since saving gets them less money than before). This means that they spend more instead. Therefore, demand shifts to the right (meaning at any given quantity, people are willing to pay more for it. This means that prices will go up to meet that demand. That increase in price is inflation.

You make a mistake in thinking that interest rates being lowered causes prices to drop. In fact, the exact opposite is true. Higher interest rates lead to lower prices. Lower interest rates lead to higher prices. It make sense: if saving your money will get you a better return, then you’ll spend less, decreasing demand, and forcing prices to be lowered to make up for the lost demand. If saving your money gets a worse return, you will spend more, increasing demand, and forcing prices up to meet the new demand.

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