1
i
2
i
Suppose income increases by Y
2
and money demand curve
shift to L , there is excess demand
for money which raises the
interest rate higher. A new equilibrium is got at point E
2
and interest
rate is i
2
. Thus money market is found to be in equilibrium at E
1
and
E
2
.
The combination of interest rate and income namely (Y
1
i
1
)
and (Y
2
i
2
) which maintain money market equilibrium are shown in
Panel ‗B‘ of the diagram.
We get the LM curve by connecting equilibrium point E
1
and
E
2
in Panel ‗B‘ where income/output
is measured on X - axis and
interest rate is measured on Y- axis.
The Slope of the LM Curve:
The greater the responsiveness of the demand for money to
income,
as measured by
„k‟, and lower the responsive of demand
for money to the interest
rate as measured by
„h‟, the steeper will
be the LM curve.
The Shift in the LM Curve:
For the
given LM curve the
supply of
real money balance is
constant. A shift in the real money balances will shift the LM curve.
An
increase in the money supply will
shift the
LM curve to the
right.
This is because an increase in the supply of money will reduce the
equilibrium rate of interest. This means
that at the same level of
income there will be lower equilibrium point.
Hence LM curve shift
to the right.
FIGURE 8.5: SHIFT IN THE LM CURVE
An increase
in the supply of money M
1
to M
2
shifts the
money supply curve to the right in Panel A of the diagram. The
demand curve L is drawn with reference
to particular level of
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