Consider the money market to better understand the horizontal LM curve.

a. What is on the left-hand side of equation (5.3)?

b. What is on the right-hand side of equation (5.3)?

c. Go back to Figure 4-2. How is the function L(i) represented in that figure?

d. Modify Figure 4-2 to represent equation (5.3) in two ways.
How does the horizontal axis have to be relabeled? What is the variable that now shifts the money demand function? Draw a modified Figure 4-2 with the appropriate labels.

e. Use your modified Figure 4-2 to show that (1) as output rises, to keep the interest rate constant, the central bank must increase the real money supply; (2) as output falls, to keep the interest rate constant, the central bank must decrease the real money supply.

Data from Figure 4-2

Transcribed Image Text:

The LM relation (equation 5.3) is Y L(i)