Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

 
Check your Progress: 
1. Define Real Money Balance 
2. Explain the slope of the LM curve. 
 
IS
LM
0
0
i
0
Y
Income / Output
InterestRate

---

1
i
2
i
8.3 FACTORS INFLUENCING EQUILIBRIUM 
INCOME AND THE INTEREST RATE : 
 
8.3.1 Monetary Influences: Shift in the LM Schedule: 
 
An expansion of monetary policy through the Open Market 
Operation (OMO) by Central Bank leads to a shift in the LM curve 
to the right (In OMO, Central Bank purchase securities in exchange 
for money through increasing stock of money). Here the important 
assumption that price level remains constant. The effect of increase 
in supply of real money balances on LM curve is shown in following 
diagram. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
FIGURE 8.7: MONETARY POLICY 
 
In Panel A of the diagram, money supply increases form
1
M  
to
2
M . This shifts the supply curve of real money balances to right. 
The demand for money is given as ‗L‘ and it is related to a 
particular level of income say ‗Y‘. 
At the initial supply of money equilibrium interest rate is i
1
. 
With increase in money supply equilibrium interest rate falls to i
2
. 
This is brought in Panel B of the diagram, where for given level of 
income ‗Y‘, the two money market equilibrium positions are shown 
as E
1
and E
2
. 
LM
1
shows the combinations of income and interest rates for 
the initial supply of money
1