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There are several things that can cause a ripple effect in our economy. There are economic facts, or things that will happen no matter what, that start to affect more and more people, until they sooner or later effect everybody. The Keynesian Transmission Mechanism is a good example of something that has a ripple effect on everybody. The Keynesian mechanism has three stages, each of which has an effect on something. The first stage is the increase or decrease in the supply of money (A- 1). The second stage is for the investment to rise or fall in conjunction with the change of the money supply (B- 1).
The third and final stage in the mechanism, is for the total expenditure / aggregate demand curve to shift accordingly to the both the money supply, and the investment. There are also some walls that block the mechanism from working, that have ripple effects on the economy. These include the Liquidity trap, and Interest-Insensitive Investment. In the first stage of the Keynesian Transmission Mechanism, the money supply is either raised, or lowered by the Fed. They do this by buying and selling bonds to the public.
If they buy bonds back, then they are essentially lowering the money supply, where as if they sell them, then they are raising the money supply. Looking at this alone, one can predict a rise or a fall in the amount of each individual has due to the scarcity of money, or the lack there of. This will have a ripple effect on the economy, because people will save more if they have less, and spend more if they have more (C- 1). For example, if the Fed were to increase the money supply would cause a surplus of money in the money market.
This in turn will have an effect on the interest rates. The interest rates will lower due to the money surplus (B- 1). Because of the lower interest rate, the AD curve will shift to the right. This happens due to a drop in the price level because of the lower interest rate. With the lower interest rate, the price of houses and cars will go down. This in turn raises total expenditures, and Real GDP.
If Real GDP raises, then the unemployment goes down, do to the inverse relationship between GDP and Unemployment. Basically this all means that when the money supply increases, there will be more money in ones pockets. With more money in ones pocket, they will be more likely to look into and possibly buy a new car or house. The resurgence of buying power by the public will cause Real GDP to shift to the right. There are also more people working to get the money. The opposite is also true (D- 1. 2. 3).
If the Fed were to decide to buy back some bonds, then the money supply would be lowered, causing an increase in the interest rate, which in turn will shift the AD curve to the left. And because of the leftward shift in the AD curve, the inverse relationship states that unemployment will be higher. Meaning that there will be fewer jobs, and more people searching for them. There are two traps in the Keynesian Transmission Mechanism. The first is called the Liquidity Trap. This occurs when the Demand for money is at a horizontal position (E- 1).
This means that it would not matter if the money supply were to be increased from S 1 to S 2, the demand would stay the same. Because of this, there would be no change in the interest rate, so investment and Real GDP would not be affected. Basically there would be more money out there, but it wouldn? t be as needed. The second trap is the Interest-Insensitive Investment.
This means that the investment would not change due to a change in the interest rate. If the interest rate doesn? t affect the investment, then the investment would not be able to cause a shift of either left or right of the AD curve. This usually happens if a firm or a corporation is expecting an increase in the interest rate, even though it is low at the time. The corporation will not be as likely to invest knowing that they will get burned later on.
Since in either way, you have an increase in the money supply, there will be a result that affects everybody. If the money supply is increased, and the AD curve doesn? t shift to the right, then there will be more money to pay to the same amount of employees. The opposite is true, if the money supply is decreased, then there will be less money to go around for the same amount of jobs. The Keynesian Transmission Mechanism is an economic tool used to show the ripple effects on economy due to the change in the money supply.
The three stages of the mechanism all have there own effects on everybody, along with there effects on each other. Be it increasing the job market, or making it easier to buy a house, the mechanism has its effects on everybody. Even when the Keynesian Transmission Mechanism gets blocked, there are still ripple affects the effect people. There could be an increase in the money supply, which would cause people to spend more, even though the interest rate stays the same. Unemployment can even be changed due to the raise or drop in money supply.
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