LECTURE 17 LM curve analysis Definition of LM curve

LECTURE 17

LM curve analysis

Definition of LM curve

LM curve show the different combination of level of national income and rate of interest it is related to the money market. it is related to the monetary policy. generally it is positively sloped, but its slope depends upon the money supply curve in the economy.

Direction of LM curve with the help of money demand and money supply approach.

Figures:

Explanation:

equilibrium in the money market required and equality between the supply of and the demand for money in this diagram we will assume that the money supply is a constant and Ms0 is the money supply curve which is a vertical straight line on x-axis. it is also assume that the supply of money is determined outside the model, that is, it is exogenous. money demand function MD = f (y,i)

Which intersect with money supply function MS0 is i0, level of national income at this rate of interest is y0 point (a) is first point for LM curve when money demand function shift upward or money demand increase. it intersect to Mso at point E1 rate of interest increase i0 + i1. in Part (b) of diagram of at level of rate of interest i1, we get 2^nd point which denoted by B for LM curve .At this point level of national y1 which is greater than y0.

If we joining these point A and B we get LM curve which has positive slope. if MSo money supply function change and it become new money supply curve ms  which is less elastic curve but not same as MSo with zero elasticity now MDo money demand curve intersect at point Eo. In part (a) diagram. point E0 is also common point of MS0 and Ms1 one at this point level of national income and rate of interest is also same as previous which are  io and yo but money demand curve md1 intersect to Ms1 at point E3 rate of interest determined by this point is i2 which is greater than io but below the I1 level when rate of interest I 2 level of national income. in Part (b) of diagram is y2 we get 2nd point for LM curve which is c. if we joining these points a and c. we get LM1 curve which is more elastic than LM0.