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Now my professor explained to me that at full employment the increase in G (gov expenditure) shifts the IS curve to the right, but at the same time the price level increase from the rightward shift in AD curve leads to the leftward shift of the LM curve, leading to interest rate increase only and no change in Y. This is how he explained crowding out, but I don’t understand the implications here.

  1. What are the firms actions that are implied in the movement of the LM curve to the left? What does its leftward shift exactly signify? How does it explain the firms crowding out from investment?

  2. And doesn’t the LM curve shift leftward at under full employment as well since P(price level) will always increase with an increase in G (AD curve shift to the right)? Why does LM not shift at under full employment when the IS curve moves to the right, but suddenly move leftward when there is full employment?

I would really appreciate if someone can give me a clear explanation on what the professor meant with this logic.

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  • $\begingroup$ What are G, IS, AD, LM and Y? $\endgroup$ – Angela Richardson Aug 8 at 4:10
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    $\begingroup$ @Angela they are macro-specific terms for the IS-LM model. See this $\endgroup$ – Brennan Aug 9 at 15:40

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