909 #
© 2014 Pearson Canada Inc.#- Using the long-run ISLM model, explain and demonstrate graphically the neutrality of
money, for the case of an increase in the money supply.
Answer: See figure below.
The increase in the money supply shifts LM to the right, increasing output to Y', above the
natural rate Y*. The interest rate falls from i to i'. Excess demand increases the price level,
reducing the real value of the money supply. The LM curve shifts back until the all pressure on
prices is eliminated by the return to the natural rate of output. The initial and final levels of
output and interest rate are the same. No real variables have changed.
Diff: 3 Type: SA Page Ref: 16
Skill: Recall
Objective List: WEB CHAPTER: The ISLM Model