Multiple choice

When interest elasticity of demand for money is zero the L - M curve is

  1. Vertical Parallel to Y-axis

  2. Horizontal Parallel to X-axis

  3. Positive Sloping straight line

  4. Negative Sloping straight line
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A Correct answer
Explanation

The LM curve shows money market equilibrium. Interest elasticity of money demand measures how much money demand changes with interest rate. When this elasticity is zero, money demand is completely insensitive to interest rates - people hold money regardless of interest rate (liquidity trap). In this case, only one income level satisfies money market equilibrium at any money supply, making the LM curve vertical (parallel to Y-axis). Monetary policy becomes ineffective.

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