Answer to Question #274630 in Macroeconomics for fatima

Question

disscuss mathematically graphically and ecnomically the major reason behind a comparatively steeper LMschedule

Answer 1

The slope of the LM curve depends upon the income elasticity and the interest elasticity of the demand for money. Income-elasticity measures the responsiveness of the demand for money to changes in income while interest elasticity measures the responsiveness of the demand for money to changes in the rate of interest. The larger the income-elasticity, and the lower the interest-elasticity of the demand for money, the steeper the LM curve will be

The initial equilibrium at point E is on the initial LM schedule that corresponds to a real money supply, M¯/P¯. Now consider an open market purchase by the Fed. This increases the nominal quantity of money and, given the price level, the real quantity of money. As a consequence, the LM schedule will shift to LM‘. The new equilibrium will be at point E‘, with a lower interest rate and a higher level of income. The equilibrium level of income rises because the open market purchase reduces the interest rate and thereby increases investment spending..