Question

(a) Explain why LM curve shift towards the right if demand for money decreases (say due to decrease in uncertainty).
(b)   Every point above the LM curve imply excess supply of money and income will increase to bring the money market back into equilibrium. True/false? Explain your answer.

Answer 1

a) The LM curve will shift right with fall in demand for money. The fall in demand for money is mainly due to the higher level of interest rate.

The rise in interest rate cause fall in investment rate and the overall production level. If the people are aware about the economic conditions; which means the reduction in uncertainty leads to fall in demand for money with respect to the market conditions. The falling demand for money causes an increase in the output level.

The falling demand for money will increase the level of savings because of the higher interest rate.

Most of the people wish to save more under the higher level of interest rate. But this will reduce the level output in the economy, because of the lack of essential investment in the economy.

b) True

The increasing money supply will maintain the imbalance in the economy. The will reign the money market equilibrium also.

The increasing demand for money in the market can be fulfilled through this increasing supply of money.

The excess supply of money will increase the real output and reduce the interest rate in the economy.

The falling interest rate will increase the investment level and the employment rate.