Why LM curve is upward sloping

CFA Level I
#1

Hi everyone,

I’m reading about LM curve but I don’t understand clearly why LM is upward sloping, because if income increase, more money will be on the market increasing the supply of money and it will be cheaper, isn’t it?

I know that my though is wrong but I don’t know why.

Thanks a lot,

#2

The assumptions underlying the LM curve are:

  • The money supply is fixed
  • Money markets are in equilibrium

So, as real GDP increases, the demand for money increases. Because the money supply is fixed and money markets are in equilibrium, the demand for money must be reduced to bring the demand back down. Increasing interest rates reduces the demand for money. Therefore, as real GDP increases, real interest rates have to increase as well.

#3

In addition to S2000, on the LM curve, the real int. rate is plotted on the Y axis and real income (GDP) is plotted on the X axis. Therefore, an increase in GDP leads to an increase in demand for money because more economic activity as a result of that the interest rate will rise. Consequently, the LM curve becomes an upward slope.