Question

please answer all, with explanations please don't know how to do it

all are graphs Qs

Using the Liquidity preference model, illustrate the effect of an increase in income (Y) on equilibrium interest rates in the money market. What, in words, is the reason for this effect? Denoting the old levels for 'T' and 'Y' as ri and Y1 and the new ones as ra and Y2, use the shock you illustrated above to map out an LM curve on a graph below:

Answer 1

According to liquidity preference theory, the demand and supply for loanable funds decide the interest rate. Generally, the supply of money is considered as fixed which is decided by the Federal Reserve. Thus, a change in the demand for liquidity preference would affect the interest rate. If there is a rise in liquidity preference, the demand for money would shift to right thereby driving up interest rate or establishing a positive relationship between the income and interest rate.

Following is the diagram:

MS LM r2 r1 MDן Y) MOY MIP. MP Y Ld Loanable fund

In above diagram, When demand for money moves up from MD(y1) to MDY2. The interest rate would also increase from r1 to r2.

LM curve has been derived from both points signifying a positive relationship between the interest rate and income level.