Question

2. Consider the monetary transmission mechanism. A disturbance to monetary equilibrium which changes the interest rate will affect aggregate demand through

		A) movements along the investment demand function and the aggregate expenditure curve.
		B) a movement along the investment demand function and a shift of the aggregate expenditure curve.
		C) a shift of the investment demand function and a movement along the aggregate expenditure curve.
		D) a movement along the aggregate expenditure curve.
		E) a shift of both the investment demand function and the aggregate expenditure curve.

Answer 1

Consider the monetary transmission mechanism.A disturbance to monetary equilibrium which changes the interest rates will affect aggregate demand through

b) a movement along the investment demand function and a shift of the aggregate expenditure curve.

(The change in the interest rates,affect the demand,output as well as prices,which cause a disturbance to the monetary equilibrium,this is known as the monetary transmission mechanism.When there is an increase in the interest rates,loans becomes costlier and also interest received on savings increases,as a result it discourages from making investments whereas encouraging consumers to save more.Savings thus exceeds consumption.Conversely a decrease in interest rates has the opposite effect on the economy.Both situations affect the monetary equilibrium,causing movements along the investment demand function as well as a shift in the aggregate expenditure curve)