Question

Discuss, using the IS-LM model, what happens to interest rates as prices change along a

given AD schedule.

Answer 1

If nominal supply,M remains constant, a decrease in the price level causes real money balances. M/p to increase and the LM curve shift to the right, the interest rate is falling to encourage demand for real money balances because there is an excess supply of them. The decrease in interest rates leads to an increase in private spending as well