how does changes in national income affects the LM curve?

Solutions

Expert Solution

LM curve:

(M/P)=L(i,Y). That is real money supply depends on interest rate and national income

The equation of LM curve is

L=KY-hi

where the K=income sensitivity of demand for real money

Y=national income

the h=interest sensitivity of demand for real money

i=interest rate

L=demand for real money

The slope of LM curve=(K/h) keeping the interest rate on the vertical axis and national income on the horizontal axis.

From this equation it is clear that demand for real money is positively related to national income and negatively related to the interest rate. So when national income increase demand for real money will be increased. It will shift the money demand curve to the right and as a result interest rate will be increased.

If K>K' that is increase income sensitivity of demand for real money,k then the slope (k/h) will be increased

Small changes in national income lead to a higher change in interest rate. In this graph, I show the effect of an increase in national income.

Rahul Sunny answered 1 year ago

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