1. A liquidity trap occurs at a very flat section of the LM curve. This can...

1. A liquidity trap occurs at a very flat section of the LM curve. This can be cause by an extreme interest elasticity of money. Which of the following are associated with a liquidity trap?

		expansionary monetary policy is ineffective
		fiscal policy becomes ineffective
		the expansionary prospects on additional money become limitless
		inflation becomes a looming problem

1B. Which of following are determinants of money demand for the Keynesian model? (select all that apply)

		transactions demand
		the interest rate
		speculative demand
		futures contracts on commodities

1C. Keynes believed that the slope of the LM curve was rather and that the slope of the IS was rather . Thus fiscal policy would be an effective remedy for economic downturns.

		flat, steep
		flat, flat
		steep, flat
		steep, steep

Solutions

Expert Solution

1(A) expansionary monetary policy is ineffective

Reason: Horizontal LM implies money demand is completely/ perfect elastic to change in rate of interest i.e. horizontal. Any increase in money supply donot raise the level of income shown through IS-LM.

Fiscal policy is most effective here as increase in government expenditure will shift the IS rightward which means increase in income

1(B)Transaction demand, interest rate and speculative demand

Reason:

1(C) flat,steep

Reason:

Rahul Sunny answered 1 week ago

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