Untitled Blair XXXXXXXXXXDepartment of Economics Macquarie University 2020 DEPARTMENT OF ECONOMICS Macquarie Business School ECON3098 THE ASIAN ECONOMIES GUIDE TO THE FINAL EXAMINATION SESSION 2 2020...

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Answered Same DayNov 09, 2021ECON3098Macquaire University

Answer To: Untitled Blair XXXXXXXXXXDepartment of Economics Macquarie University 2020 DEPARTMENT OF ECONOMICS...

Preeta answered on Nov 12 2021
143 Votes
Liquidity Trap:
The situation where the savings rates are high and interest rates low is known as liquidity trap since in that situation, monetary policies become ineffective (Werning 2011
). The reason for the low interest in spite of high savings can be that the consumers expect the interest rate to rise sooner and so they invest in cash savings rather than in bonds and other forms of investment since increase in interest are will result in the fall of the bond price and so the investors fear to suffer loss in the long run. Under such condition even if the federal bank of the nation try to increase the supply of the money and revive the interest rate, it is of no use.
The above diagram presents the liquidity trap since the LM curve is flat that is there is no movement in the monetary market. So, even if IS curve shifts due to government investment or due to any other factor, there is no change on the interest rate and just the output level changes.
IS – LM Model:
IS refers to investment savings and LM refers to the liquidity preference money supply. The IS curve represents the economic goods market and LM curve represents the money market and the model shows the interpretation between these two markets. The interest rate and the output are determined by the interaction of the two curves (Ball 2014).
The equation of IS curve is Y = C (Y- T) + I + G
Where, Y = Total production
C = Consumption
T = tax
I = investment
G = government grants
The equation for LM curve is M/P=L(i,Y)
Where, M = the amount of money offered, 
Y = real income
i = real interest rate,
L = the demand for money,
L is the function of i and Y.

The above diagram shows the IS – LM model. In the diagram, it has been depicted that a shift of the IS curve right is increasing the interest rate from i1 to i2 and so the output level is also...
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