Question

For this question assume that the real money demand function is L(R, Y) = kY - hR where k > 0 represents the sensitivity of the money demand to income and h > 0 represents the sensitivity of the money demand to the interest rate. Suppose that the economy of Highland has high k and low h, while the economy of Lowland has low k and high h. If the two countries are the same other than the above difference, compare and contrast the effectiveness of the fiscal policy in Highland and Lowland

Answer 1

ANSWER:-

Md= kY-hR

k = Interest elasticity of Income

h= Interest elasticity of Money Demand

Effectiveness fiscal policy is depend on the slope of LM curve = dr/dy = k/h

FLATTER the LM curve most would be the effectiveness of  FISCAL POLICY and vice-versa.

• IN HIGHLAND

if k is high and h is low  then the slope of LM curve would be more and it become more steeper that means Fiscal Policy is ineffective.

• IN LOWLAND

if  k is low and h is high then the slope of LM curve would be less and it become more flatter. that means Fiscal Policy is most effective.