Assume the Keynesian transmission mechanism is operational and the economy is currently operating in the horizontal portion of the AS curve.If the money supply decreases and the demand for money curve is downward sloping and investment is interest-____________,then Real GDP will ___________________.
A) sensitive; fall
B) insensitive; fall
C) sensitive; rise
D) insensitive; rise
E) sensitive; remain unchanged

Question

Quizplus · Accepted Answer

In the Keynesian model, a decrease in the money supply will lead to an increase in interest rates, since there is now less money available for borrowing. This increase in interest rates will in turn cause a decrease in investment, since it will be more expensive to borrow. As investment falls, aggregate demand will also fall, causing a contraction of Real GDP. The fact that the demand for money curve is downward sloping means that it is sensitive to changes in interest rates, which reinforces the effect of the decrease in the money supply. Thus, Real GDP will fall, and the best choice is A.

Assume the Keynesian Transmission Mechanism Is Operational and the Economy