An increase in money supply shifts the LM curve to the right, but an increase in...

An increase in money supply shifts the LM curve to the right, but an increase in money demand shifts the LM curve to the left. Giving reasons, explain why there is a difference. (150 words maximum)

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Expert Solution

The LM curve presents the relationship between liquidity and money. In a closed economy, the interest rate is fixed by the equilibrium of supply and demand for money: M/P=L(i,Y) regarding M the amount of money supply, Y real income and i real interest rate, being L the demand for money, which is function of i and Y.
An increase in money supply shifts the LM curve to the right, because a decrease in the price level increases the real money supply so people can buy more with the money they have. The decrease price level shifts the money supply line outward. This causes the LM curve to shift down.
Diagram:-1
An increase in money demand shifts the LM curve to the left, this happens because at any given level of income and money supply, the interest rate complusary to equilibrate the money market is higher. The upward shift in the LM curve decreases income and raises the interest rate.

Rahul Sunny answered 1 year ago

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