The economy is in the horizontal portion of the AS curve,there is no liquidity trap and investment is sensitive to changes in the interest rate.According to the Keynesian transmission mechanism,if the money supply drops the interest rate will __________,investment spending will __________,the AD curve will shift to the __________,and the price level will __________.

Question

Quizplus · Accepted Answer

In the Keynesian transmission mechanism, a drop in the money supply leads to higher interest rates as there is less money available for borrowing. Higher interest rates make borrowing more expensive, which reduces investment spending. With lower investment spending, the aggregate demand (AD) curve shifts to the left. However, because the economy is in the horizontal portion of the AS curve, output changes but the price level does not change, reflecting excess capacity or slack in the economy.

The Economy Is in the Horizontal Portion of the AS Curve,there