Answer to Question #261256 in Macroeconomics for Nimessi

Question

Why the income and interest sensitivities of the demand for real balance affect the slope of LM curve?

Answer 1

The curve is derived using demand and supply of money. When there is equilibrium in money market it shows a positive relationship between real GDP and interest rate. The slope of the demand for money curve is reduced by increase in interest sensitivity for real balance. A relatively small decrease in interest rate causes a large increase in the demand for money because the slope is not very steep. An excess demand for real money balances at the old equilibrium rate is increased by demand for real money thus inducing adjustment in the money market.