Question

Define LM Curve and shoe how it derived? Explain in which direction and why LM curve shifts when there is:

a. An increase in money supply

b. A decrease in money supply.

Answer 1

Define LM Curve?

Ans:- LM curve defines the realtionship between the interest rate and income and its calculate the demand for money. Eqution of LM curve is  L = k * Y - h * I where as L = Deamand for money , Y = Income , I = Inerest rate , k= coefficient of Income and h = coefficient of Interest.

The Graphical derivitation of LM curve slopes shows upwards from left to right because given the money supply which increase in level of income increase in the demand for money which leads to higher interst rate ,

Directions of LM curve

1) LM curve shifts upwards to the right when the money supply is increased and shifts invers then the money supply is reduced.

2) LM curve shifts upwards to the left when the money demand is increased which raises the quantity demanded at a interest rate and income level and LM curve shifts download to the left if there is a decrease in the money demand which lowers the amount of money demanded at a given level of income and interest .

why LM curve shifts when there is:

a. An increase in money supply

ans:- Increase in money supply brings down the interest rate which leads to increase the investment there by raising the income level .

b. A decrease in money supply.

Ans:- Decrease in money supply means increase in demand for money set up highere interest rate and lower income level .