A change in which of the following would cause the LM curve to shift? To rotate?...

A change in which of the following would cause the LM curve to shift? To rotate? To both shift and rotate? Which do not affect the position or slope of the LM curve?
1. nominal money supply
2. responsiveness of the demand for money to the interest rate
3. responsiveness of the demand for money to income
4. business and consumer confidence
5. interest rate (r)
6. price level (P)

Expert Solution

LM curve represents the combination of income and rate of interest which keeps money market at equilibrium.

M/P = L( r, Y)

where r is the rate of interest and Y is the income

a. Now due to an increase in the nominal money supply increases M/P assuming P is fixed. Now for a given level of income increase in money supply causes a decline in the interest rate. As LM is a function of interest rate. Thus the LM curve will shift downward.

b. Responsiveness of the demand for money to the interest rate is called interest elasticity of demand. Higher responsive is the demand for money to the interest rate that is higher is the interest elasticity of demand LM curve will be horizontal or parallel to the horizontal axis.

c. Responsiveness of the demand for money to income is known income elasticity of demand for money. Higher is the responsiveness of demand for money to income, steeper will be the LM curve and lower income elasticity of demand for money implies flatter LM curve

d. Decrese in the business and consumer confidence will cause a decline in the consumption expenditure and Investment. We know equation Of IS curve is Y= C+I+G

As C and Declines,, IS curve will shift leftward and There will be no change in the LM curve.

e. An increase in the rate of interest reduces transaction demand for money I.e. the demand for money. Now To keep the money market at equilibrium we must move along the LM curveball a result of which income increases.

f. Now an increase in the price level will lower the real money balance I.e. M/P. Thus the LM curve will shift upward as a result of which output or income declines. And interest rate increases.

Rahul Sunny answered 3 hours ago

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