LM schedule for Money and banking, SM schedule.

2. The LM schedule
Money and banking
Authorizer: Dr. Abdul Qadeer khan

3. Outline
• Money market
• Equilibrium interest rate
• Level of real income determination
• Goal
• LM schedule
• Formation
• Derivation of the LM schedule
• Determinants of the LM schedule
• Shifts in the LM schedule
• Effects of Fiscal and Monetary Policy

4. Money market

5. Money market
• Is the segment of financial market in which highly liquid assets are
traded e.g. (P.I.B) Pakistan investment bonds, forex exchange rate and
currency exchange.
• LM deals with the money market where as IS schedule deals with
goods market
• Equilibrium of the money market requires equality between the
supply and the demand for money.
Ms = Md

7. Equilibrium interest rate &
Level of real income determination

8. Equilibrium interest rate
• Factors
Nominal supply of money
Level of price
Other factors that influence public demand for real
purchasing power
Level of real income
• Level of real income determination:
Equilibrium level of real income is determined by the level of desired
expenditures in the economy

9. Goal

10. Goal
• To take the locus combination of Y & r
Equilibrium real interest rate ( r ) Equilibrium level of real income( Y )
How simultaneously determined

11. History and information of LM schedule

12. LM schedule
• 1937 john hicks derived the LM schedule.
• It is a Set of points which represents.
“All the combination of real income and interest rate for
which the market is in equilibrium”
• Before it was named as LL schedule but now LM as :
holdings of money balance (liquidity) L= quantity of money
balance supplied M

13. Formation

14. Formation
• The model is presented as a graph of two intersecting
lines in the first quadrant.
Horizontal axis represents real income or real GDP (y)
Vertical axis represents the real interest rate (r) .
Point of intersection is called equilibrium point MD/P = MS/P.
Take demand curve as real money demand MD/P
Take supply curve as real money supply MS/P.

15. Formation
Interest rate
MD/P
Y
Real income
MS/P
re
0
r

16. Assumption
•Take real money supply constant (Ms/p).
And assume that it is fixed by the central
bank.
•If not then the locus combination will not
be in same position

17. Deriving the L-M Curve

18. Derivative of the LM schedule
• Previous chapter that : If real money supply falls then our demand
will shift towards leftward
• If real money supply increase then our demand curve will move
towards rightward.

19. If real money supply increase(upward)
figure 4a

20. More elaboration ……….

21. Deriving the L-M Curve
• If we plot the equilibrium points on a separate graph then we will get
the LM schedule as it justify the definition:
“All the combination of real income and interest rate
for which the market is in equilibrium”

22. Deriving the L-M Curve (figure 4b)

23. More elaboration ……….

24. More elaboration ……….

25. Determinants of the LM schedule

26. Determinants of the LM schedule
The slope of the L-M curve depends on
• the interest sensitivity/ elasticity of the speculative
demand for money
• the income elasticity of money demand

27. Shifts in the LM schedule

28. Properties of LM Curve
• Upward sloping,
Y  L  i*  Increase/Decrease in the real money
supply shift the LM curve Rightward/Leftward.
• The steepness or flatness of the LM curve describes the
elasticity or responsiveness of money demand to the
nominal interest rate.
-- Steep LM curve: inelastic.
-- Flat LM curve: elastic.

29. • An increase in money
causes the LM curve
to shift down (right)
Shifts in LM Curve due to change in Money
Supply

30. Shifts in the LM schedule(right)

31. Shifts in the LM schedule(left)

32. Effects of Fiscal and Monetary Policy

33. Some important consideration
• Taxes affect the IS curve, not the LM curve.
• Monetary policy does not affect the IS curve, only the LM curve.
• For example, an increase in the money supply shifts the LM curve
down.
• Monetary contraction, refers to a decrease in the money supply
(leftward shift)
• An increase in the money supply is called monetary
expansion(rightward shift)

34. Effects of Fiscal and Monetary Policy