Suppose that IS and LM intersect at full-employment output. A rightward shift of LM will be followed by a __________ price level that shifts LM to the __________ in a return to full employment.

Question

Quizplus · Accepted Answer

A rightward shift of the LM curve, which represents a situation where money supply increases or interest rates decrease leading to higher investment and income, initially moves the economy away from full employment by increasing output beyond the full-employment level. This increase in output leads to higher demand for goods and services, which puts upward pressure on prices. As prices rise, the real money supply (which is the nominal money supply adjusted for price level) decreases because the money does not go as far when prices are higher. This decrease in the real money supply shifts the LM curve back to the left as it requires higher interest rates to equilibrate the money market at the higher price level, eventually returning the economy to full employment but at a higher price level.

Suppose That IS and LM Intersect at Full-Employment Output