In aggregate demand analysis, the foreign purchases effect (also called the net export effect) of a change in the domestic price level does which of the following?

Introduction / Context:
One of the reasons the aggregate demand curve slopes downward is the foreign purchases effect, also known as the net export effect. This effect explains how changes in the domestic price level influence exports and imports, and through them the quantity of real output demanded. The question asks whether this effect shifts the aggregate demand curve or causes movement along an existing curve.

Given Data / Assumptions:

• The domestic price level can rise or fall relative to price levels in foreign countries.
• Exports become more or less competitive when domestic prices change compared with foreign prices.
• Net exports equal exports minus imports and are a component of aggregate demand.
• Other determinants of aggregate demand, such as fiscal policy and consumer confidence, are held constant while we consider the price level change.
• The foreign purchases effect is one of several reasons for the inverse relationship between price level and quantity of real GDP demanded.

Concept / Approach:
The foreign purchases effect describes how a change in the domestic price level influences net exports and thus the quantity of real output demanded. When the domestic price level falls relative to foreign prices, domestic goods become cheaper for foreign buyers, exports rise, imports fall, and net exports increase. This increases the quantity of output demanded. When the domestic price level rises, domestic goods become relatively more expensive, net exports fall, and the quantity of output demanded decreases. These changes occur along a given aggregate demand curve as the price level on the vertical axis changes. A shift in the aggregate demand curve would require a change in some non price determinant, such as foreign income or trade policy, not just a change in the domestic price level itself.

Step-by-Step Solution:
Step 1: Recall that aggregate demand relates the quantity of real GDP demanded to the overall price level in the economy.Step 2: Understand that the foreign purchases effect focuses on how the domestic price level affects net exports, which are part of aggregate demand.Step 3: If domestic prices fall, exports become more competitive and imports less attractive, so net exports and the quantity of output demanded rise.Step 4: If domestic prices rise, exports become less competitive and imports more attractive, so net exports and the quantity of output demanded fall.Step 5: These changes correspond to movement along an existing aggregate demand curve because the price level on the vertical axis is changing.Step 6: Therefore, the foreign purchases effect moves the economy along a fixed aggregate demand curve and does not itself shift the curve.

Verification / Alternative check:
Macroeconomic diagrams show the aggregate demand curve as downward sloping due to three main effects: the real balances effect, the interest rate effect, and the foreign purchases effect. Each of these explains how a change in the price level causes a change in the quantity of real output demanded, resulting in movement along the curve. Texts then distinguish these movements from shifts, which are caused by changes in determinants such as government spending, taxes, or foreign income. This confirms that the foreign purchases effect is associated with movement along a given aggregate demand curve.

Why Other Options Are Wrong:
Options a and c describe leftward or rightward shifts of aggregate demand, which would require changes in non price factors like foreign income or trade policy, not simply the price level change. Option d incorrectly links the foreign purchases effect to aggregate supply, which is about production capacity and input costs rather than net exports. Option e states that both aggregate demand and aggregate supply shift simultaneously, which is not what the foreign purchases effect specifically describes.

Common Pitfalls:
Students sometimes confuse reasons for the slope of a curve with factors that shift the curve. The foreign purchases effect, like the interest rate effect, explains why the aggregate demand curve slopes downward but does not by itself move the curve left or right. To avoid this confusion, it is useful to remember that a change in the variable on the vertical axis, the price level, produces movement along the curve, while changes in other determinants shift the entire curve.

Final Answer:
The foreign purchases effect moves the economy along a fixed aggregate demand curve as the domestic price level changes.