Ripple Effects Upon Economy
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 S1 to S2, 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.