Question
4. Consider the money market to better understand the horizontal LM curve in this chapter. The money market relation (equation 5.3) is M P =
4. Consider the money market to better understand the horizontal LM curve in this chapter. The money market relation (equation 5.3) is M P = Y L1i2 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 4-3 in the previous chapter. How is the function L(i) represented in that figure? d. You need to modify Figure 4-3 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 4-3 with the appropriate labels. e. Use your modified Figure 4-3 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
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