When the LM curve shifts to the right, what happens to the equilibrium interest rate and income?a)Interest rate increases, income increasesb)Interest rate decreases, income increasesc)Interest rate increases, income decreasesd)Interest rate decreases, income decreasesCorrect answer is option 'B'. Can you explain this answer?

Question

Answer

When the LM curve shifts to the right, the equilibrium interest rate decreases, and income increases.

Answer

The LM curve represents the equilibrium in the money market, showing all combinations of interest rates and income levels where the supply of money equals the demand for money. When the LM curve shifts to the right, it means that at each interest rate, there is now a higher level of income at which the money market is in equilibrium.

Effect on Equilibrium Interest Rate and Income:
- Interest Rate Decreases: With the LM curve shifting to the right, the equilibrium interest rate decreases. This is because at each level of income, people are willing to hold a larger quantity of money at the given interest rate. As a result, the interest rate needs to decrease to encourage people to hold the increased money supply.
- Income Increases: The shift of the LM curve to the right also leads to an increase in equilibrium income. This is because, at the lower interest rate, people are now willing to borrow more money for investment purposes. This increase in investment spending leads to an increase in overall income levels in the economy.
Therefore, when the LM curve shifts to the right, the equilibrium interest rate decreases, while the equilibrium income increases. This signifies a situation where people are willing to hold more money at lower interest rates, leading to higher levels of investment and income in the economy.

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