1.

Explain the Keynesian Transmission Mechanism– When the money supply increases, the
Keynesian transmission mechanism works as follows: an increase in the money supply lowers
the interest rate, which causes investment to rise and the AD curve to shift rightward. Real
GDP increases and the unemployment rate drops.
= According to the Keynesian transmission mechanism an increase in the money supply lowers
the interest rate, which causes investment to rise and the AD curve to shift rightward. As a
result, Real GDP increases and the unemployment rate decreases. It is an indirect form of
transmission that indicated a change in the money market creates the final effect on the good
and service market through the medium of Investment Goods Market.

2. What happens in link between interest rate and investment is broken? what is the situation
called? Why does Keynes say that the link is broken?
Answer- Some Keynesian economists believe that investment is not always responsive to
interest rates.
The Keynesian transmission mechanism would be short-circuited in the investment goods
market, and the link between the money market and the goods and services market would be
broken.
If fall in interest rate does not lead to a rise in investment, AD will not shift, Real GDP and
Unemployment will remain changed.
3. Keynesians have sometimes argued that the demand curve for money could become
horizontal at
some low interest rate.
At that interest, even if money supply is increased, individuals are willing to hold all the
additional
money supply at the given interest rate. As a result, an increase in Money supply does not lead
to a fall in interest rate. The rest of the mechanism does not occur.

In case of monetarism, velocity is said to change in a predictable way. What are the three
variables that can be used to determine velocity? For each, identify what must happen to
these three variables if each of them leads velocity to fall.

3. One-shot demand induced inflation can turn into continued inflation

To create continued inflation, aggregate demand must increase; which can happen because the
Government or the central bank may react to the rise in unemployment by increasing
aggregate demand.
Aggregate demand keeps increasing and the process just described repeats indefinitely.

a) Ans: According to the Keynesian transmission mechanism an increase in the

money supply lowers the interest rate, which causes investment to rise and the AD
curve to shift rightward. As a result, Real GDP increases and the unemployment rate
decreases. It is an indirect form of transmission that indicated a change in the money
market creates the final effect on the good and service market through the medium of
Investment Goods Market.
Velocity changes in a predictable way: Velocity is assumed to be constant in simple
quantity theory of money. But Monetarists assume that velocity is not constant, rather
it changes and it changes in a predictable way and not randomly. Monetarists believe
that velocity have three different factors. Which are the interest rate and it is inversely
related to velocity, the expected inflation rate which is positively related to velocity
and, the frequency of paychecks that the employees receive which is also positively
related to the velocity with which money changes hands