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| (a) | (d) | |
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| (b) | (c) |
At interest rates r0 and r1, investment levels in panel (a) will be i0 and i1. To generate equilibrium in the product market, levels of income must be at y0 and y1 respectively. Therefore, interest rate income combinations r0, y0 and r1, y1 are equilibrium points along the IS schedule which slopes downward to the right.
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| (a) | (b) |
An increse in income from y1 to y2 will shift the money demand schedule to the right. To generate equilibrium in the money market, interest rate must be at r2. Therefore, interest rate income combinations r1, y1 and r2, y2 are equilibrium points along LM schedule which slopes upward to the right.
in interest rate, the flatter is the IS curve
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| (a) | (d) | |
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| (b) | (c) |
With investment being sensitive to changes in interest rates, the investment schedule i'(r) on panel (a) is relatively flat. A fall in interest rate will increase investment by a large amount. Hence, a large increase in income, y0y2, is required to restore the product market equilibrium. Therefore, the IS' schedule in part (d) will be flat.
in interest rates, the steeper is the LM curve
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| (a) | (b) |
With a low interest elasticity of money demand, the demand for money schedule on panel (a) is relatively steep. An increase in income from y1 to y2 will lead to an excess demand for money. Given fixed money supply and low interest elasticity of demand for money, a relatively large increase in interest rate (r3) is required to eliminate the excess money demand. Thus, the LM' schedule is relatively steep.
