LM-curve in the AS-AD model, Macroeconomics

The LM-curve in the AS-AD model 

The LM-curve will shift upwards (downward) when P is increases (decreases)

in the AS-AD model is moved

LM-curve in the AS-AD model is slightly more complicated as P will affect the demand for money. In IS-LM model, LM-curve is defined as all combination of R and Y where money market is in equilibrium, that is, where demand for money is equal to supply of money, MD(Y, R) = MS

In AS-AD model, LM-curve demonstrates all combinations of R and Y, where money market is in equilibrium for a given P. For a given P, we may still draw LM curve in the AS-AD model just as we did in IS-LM model. For a given P, there are numerous combinations of R and Y where money market is in equilibrium. Besides for another given P, another set of combinations of R and Y would be associated with equilibrium in the money market. It means that LM-curve will shift when P changes. 

2351_LM-curve in the AS-AD model.png

Figure: Money market diagram with different prices

1. First consider top left figure. Demand curve for money, MD1 is drawn for Y = 100 and P = 10. Equilibrium interest rate is R = 5%. 

2. Y = 100 and R = 5% will provide us with a point on the LM1 curve to the right. 

3. Now assume that P increases to 20. We know that demand for money will increase and curve will shift to the right (to MD2). 

4. We see that R = 5% and Y = 100 is no longer an equilibrium in money market. 

5. To the left you see that R = 7% would be an equilibrium when Y = 100 for P = 20. 

6. R = 7% and Y = 100 should be on a new LM curve (LM2) associated with higher price P = 20. 

There is an LM curve for P = 10 (LM1) and an LM curve for P = 20 (LM2). The significant thing to remember is that in AS-AD model, there is one LM-curve for each value of P. When P increases, LM curve will shift to a new curve that will be above the old one. Reason, again, is that R should increase when P increases to keep the money market in equilibrium.

Posted Date: 8/16/2013 2:21:10 AM | Location : United States







Related Discussions:- LM-curve in the AS-AD model, Assignment Help, Ask Question on LM-curve in the AS-AD model, Get Answer, Expert's Help, LM-curve in the AS-AD model Discussions

Write discussion on LM-curve in the AS-AD model
Your posts are moderated
Related Questions
Compared with the situation before 1981, the marginal tax rates imposed on individuals and families with high incomes are now lower. What was the top marginal personal income tax r


Q. Define Effective exchange rate? Suppose that we are interested in external competitiveness of a country, let's say Japan. To do this we could look at evolution of a particul

what are the advantages and disadvantages of a national income and green GDP? national income figures are often used to compare living standards across countries and through time.

Q. What do you meant by Investment? When we use the word investment, we characteristically mean 'gross investment'. Fundamentally, gross investment comprises all finished goods

Suppose a major brokerage firm advised its clients to buy cigarette stocks under the assumption that, if consumer incomes rise by 50% as expected over the next decade, cigarette sa

Relate overnight interest rates with interest rates By controlling overnight interest rates, the central bank will affect the interest rates with longer maturity. The reason f

Explain a circular flow of income in a frugal econmomy with diagram

Butthole Industries is buying out Avengers, Inc.  Butthole and Avengers both have market capitalizations equal to their fair value or the present value of their net cash flows.  Bu

Suppose the demand for guitars in State College is given by Qd = 9000 - 12P where Qd is the quantity demanded, and P is the price of guitars. Also, suppose the supply of guitars is