Page 177 - DECO402_Macro Economics

Macroeconomic Theory

Notes In figure 18.10, the related steepness and flatness of LM Curve is shown. LM Curve is comparatively
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steeper in comparison to LM Curve and LM Curve is comparatively flatter. In the case of LM Curve,
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money demand is very sensitive from change in actual GDP and the interest rate is less sensitive from
the change in demand of money. In the case of LM Curve, money demand is less sensitive from
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change in actual GDP and is more sensitive from the change in interest rate.

Task Express your view about IS Curve and it’s derivation.

Shift in LM Curve

It is considered while tracing the LM Curve that Price level and supply remain constant. If any one
of these considerartion is removed then there will be a shift in LM Curve. We concentrate on supply
of money. We’ll want to see how LM Curve shifts on the rise or fall in supply of money. It is shown
in figure 18.11 (A and B).
Two parameters affecting slope of LM Curve
1. The sensitivity of money demand for the changes in GDP: The sensitivity of money
demand for the change in GDP will be as higher; LM line will be as steeper and vice-versa.
Because the mean of more sensitivity of money demand for the change in GDP is the more
shift of L curve towards right. It’s mean is the steepness of LM line and the more rise in r
because of a definite change in GDP.
Note: Here the implication of more sensitivity for the changes in GDP is the situation of Marginal
Propensity to Consume – MPC, because the demand of money rises for the deals of transaction on
the rising in GDP not for speculative purpose.
2. The sensitivity of money–demand for changes in ‘r’: The sensitivity of money demand
for changes in ‘r’ means the slope of L curve. Clearly, the slope of L-curve affects the slope
of LM curve. The sensitivity of money demand for changes in ‘r’ is as larger the L-curve
will be as flatter. L-curve is as much flatter as low change in ‘r’ is there; for any horizontal
shift of L curve. (Because of changes in GDP, no doubt, as low changes in ‘r’ LM Curve
will be as flatter.) In brief, as higher will be the sensitivity of money demand for changes
in ‘r’ the LM Curve will be as flatter and vice versa.
Note: About the slope of L curve money demand is the demand of money for speculative purpose
because only for speculative purpose the demand of money is directly related with r, not for the deals
of transaction demands.
In part (A) of figure 18.11, the initial balance of money market is on point E, where the supply of
real balances is equal to demand of real balances. Point E* similar to point E in part (A), shows the
balance of money market which is from a fixed level of the balanced interest rate r and GDP (=y ).
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When supply of money raises then line M shifts from M to M . On being other things constant it
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means the fall of the balanced interest rate from r to r . It is such situation where the low balanced
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interest rate is found and which is similar as that level of GDP. The part B is shown by point E in this
situation. Accordingly LM Curve shifts towards right (LM to LM ) so that could pass through point
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E. The rise in money supply creates such situation where, on each level of GDP, lower interest rate
is circulated in the market which is shown as the right shift of LM Curve. Similarly, when there
is a fall in money supply and line M shifts towards left, then the interest rate should be increased
according to each level of GDP, i.e., the left shift of LM Curve.

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