to the interest rate (because ris the opportunity cost of holding money) and positively related to income (because of transactions demand).

Chapter Ten21rM/PM/PSupplyDemand, L (r,Y)Since the price level is fixed, a reduction in the money supply reducesthe supply of real balances. Notice the equilibrium interest rate rose.A Reduction in the Money Supply: -M/PSupply'

Chapter Ten22rM/PM/PSupplyL (r,Y)'L (r,Y)r1r2rYLMAn increase in income raises money demand, which increases theinterest rate; this is called an increase in transactions demandfor money. The LM curve summarizes these changes in the moneymarket equilibrium.

Chapter Ten23rM/PL (r,Y)rYLMM/PSupplyA contraction in the money supply raises the interest rate that equilibratesthe money market. Why? Because a higher interest rate is needed to convince people to hold a smaller quantity of real balances.As a result of the decrease in the money supply, LMshifts upward.r1r1M´/PSupply'LM'r2r2

Chapter Ten24rYLM(P0)ISr0Y0The intersection of the IS curve/equation, Y= C (Y-T) + I(r) + Gand the LMcurve/equation M/P = L(r, Y)determines the level of aggregate demand.The intersection of theISand LM curves represents simultaneous equilibrium in the market for goods and services and in the market for real money balances for given values of government spending, taxes, the money supply, and the price level.The intersection of the IS curve/equation, Y= C (Y-T) + I(r) + Gand the LMcurve/equation M/P = L(r, Y)determines the level of aggregate demand.The intersection of theISand LM curves represents simultaneous equilibrium in the market for goods and services and in the market for real money balances for given values of government spending, taxes, the money supply, and the price level.

Chapter Ten25IS-LM ModelIS CurveLM CurveKeynesian crossGovernment-purchases multiplierTax multiplierTheory of liquidity preferenceIS-LM ModelIS CurveLM CurveKeynesian crossGovernment-purchases multiplierTax multiplierTheory of liquidity preference