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) Derive (again!) the LM curve from considering how income increases affect money
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- Derive the LM Curve by illustrating what happens in the market for money when there is a decrease in income.Derive two LM curves, the first when money demand is very sensitive to the interestrate, and the second where money demand is insensitive to the rate of interest. Show howthe slopes of the LM curves differQ15 Which of the following statements is consistent with a given (i.e., fixed) LM curve? Select one: a. A reduction in the interest rate causes money demand to decrease. b. A reduction in the interest rate causes investment spending to increase. c. An increase in output causes an increase in demand for goods d. An increase in output causes an increase in money demand.
- Using diagrams illustrating the market for money and the LM Curve, illustrate what happens when the supply of real money balances increases.If nominal money demand is proportional to nominal income, by how much will real money demand increase if real income rises 10%.True or false? According to the LM schedule , money supply is a function of income and interest rate.
- Explain how increases in the real interest rate affect the quantity of real money balanced demanded. (Graphically illustrate)Consider an economy described by the following equations:Y = C + I + G (1)C = 100 + 0.75(Y − T) (2)I = 500 – 50 r (3)G = 125T = 100where Y is GDP, C is consumption, I is investment, G is government purchases, T is taxes, and r is the interest rate. If the economy were at full employment (that is, at its natural rate), GDP would be 2,000.1. Suppose the central bank’s policy is to adjust the money supply to maintain the interest rate at 4 percent, so r = 4. Solve for GDP. Is it greater or lower than full-employment level? How much 2. Assuming no change in monetary policy (as was in part i), what change in government purchases would restore full employment?1. Assuming no change in fiscal policy, what change in the interest rate would restore full employment?Draw the money demand function in an interest rate-real money balances diagram,and show how it shifts as income changes.
- Explain, and graphically illustrate, how a decrease in the supply of real money balances will affect equilibrium in the market for money. Derive the LM Curve by illustrating what happens in the market for money when there is a decrease in income. (See page 325 of your text for an example.) Using diagrams illustrating the market for money and the LM Curve, illustrate what happens when the supply of real money balances increases. (See page 326 of the textbook for an example.)Assume that following equations describe the money market of an economy Ms = 1,000 Md = .2Y - 100r Calculate the LM curve for this economy. Now assume that the money supply rises to 1,200. How much and in what direction has the LM curve shifted?What are the implications of drawing an LM curve for money market equilibrium if a) money supply is kept fixed, b) the interest rate is kept fixed, and c) an intermediate policy is adopted looking at both interest rates and monetary aggregates?