If real money balances enter the IS-LM model both through the theory of liquidity preference and the Pigou effect, then a fall in the price level will shift:
A) only the LM curve.
B) only the IS curve.
C) both the LM and the IS curves.
D) neither the LM nor the IS curve.

Question

Quizplus · Accepted Answer

A fall in the price level would increase real money balances, which would increase spending and therefore shift the IS curve to the right. At the same time, the increase in real money balances would lower interest rates, shifting the LM curve to the right. Therefore, both the LM and IS curves would shift.

If Real Money Balances Enter the IS-LM Model Both Through