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IS – LM Model
(Graphical
Approach)
The Goods and The Money
Market
Equilibrium According to Keynes, Equilibrium of the
goods market is achieved when planned
saving is equal to planned investment.
S = I
OR
Y = C + I
 Equilibrium of the money market requires
equality between the supply of and the
demand for money.
Ms = Md
Equilibrium in the Goods
Market
 In developing the IS model, investment is
considered as a function of rate of interest
, consumption and saving as functions of
income.
Investment Function : I = I(r)
Consumption Function : C = C(Y)
Saving Function : S = S(Y)
 Equilibrium in the goods market is
achieved when : -
S(Y) = I(r)
 However, this relationship may be shown
graphically as follows
IS Curve
 Re-translation of Simple
Keynesian model at equilibrium
(Investment = Saving).
 A plot of equilibrium output for
various interest rates within the
market for goods and services.
Determining Output
Two characteristics of ZZ are:
Because it’s assumed that the
consumption and investment
Relations are linear, ZZ is,
in general, a curve
rather than a line.
ZZ is drawn flatter than a 45-
degree line because it’s
assumed that an increase in
output leads to a less than one
for-one increase in demand.
Deriving the IS Curve
 Deriving the IS Curve
(a) An increase in the interest
rate decreases the demand
for goods at any level of
output, leading to a decrease
in the equilibrium level of
output.
(b) Equilibrium in the goods
market implies that an
increase in the interest rate
leads to a decrease in
output.
Properties of IS Curve
 Increase/Decrease in autonomous
expenditure will shift the IS curve
Rightward/Leftward.
 There is an inverse relationship between
income(Y) and rate of interest(ROI)
 The steepness or flatness of the IS curve
determine its elasticity
-- Steep IS curve: inelastic.
-- Flat IS curve: elastic.
Equilibrium in the Money
Market
 Money Market Equilibrium is
achieved when the supply of
money and demand for money
are equal.
Ms = Md
LM Curve
 Depicts equilibrium in the Money market
(L = M).
 A plot of the equilibrium interest rate for
various levels of output or income,
within the money market for a given
level of the nominal money supply.
Deriving the LM Curve
 An increase in
income leads, at a
given interest rate,
to an increase in
the demand for
money. Given the
money supply, this
increase in the
demand for money
leads to an
increase in the
equilibrium interest
rate.
 Equilibrium in the
financial markets
implies that an
increase in income
leads to an
increase in the
interest rate. The
LM curve is
therefore upward
sloping.
Deriving the LM Curve
Properties of LM Curve
 Upward sloping,
Y  L  i*
 Increase/Decrease in the real money supply
shift the LM curve Rightward/Leftward.
 The steepness or flatness of the LM curve
describes the elasticity or responsiveness of
money demand (L) to the nominal interest
rate.
-- Steep LM curve: inelastic.
-- Flat LM curve: elastic.
(L=speculative demand for money)
Conclusion
 IS Curve represents the equilibrium
of the goods market.
 LM Curve represents the
equilibrium of the money market.
 The point of intersection of the two
curves is the point of equilibrium of
both the markets simultaneously.
A Presentation By : -
 PRATEEK
BANSAL
 VIVEK RATHI
 DEBANKITA PAUL

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Islm

  • 1. IS – LM Model (Graphical Approach)
  • 2. The Goods and The Money Market Equilibrium According to Keynes, Equilibrium of the goods market is achieved when planned saving is equal to planned investment. S = I OR Y = C + I  Equilibrium of the money market requires equality between the supply of and the demand for money. Ms = Md
  • 3. Equilibrium in the Goods Market  In developing the IS model, investment is considered as a function of rate of interest , consumption and saving as functions of income. Investment Function : I = I(r) Consumption Function : C = C(Y) Saving Function : S = S(Y)  Equilibrium in the goods market is achieved when : - S(Y) = I(r)  However, this relationship may be shown graphically as follows
  • 4. IS Curve  Re-translation of Simple Keynesian model at equilibrium (Investment = Saving).  A plot of equilibrium output for various interest rates within the market for goods and services.
  • 5. Determining Output Two characteristics of ZZ are: Because it’s assumed that the consumption and investment Relations are linear, ZZ is, in general, a curve rather than a line. ZZ is drawn flatter than a 45- degree line because it’s assumed that an increase in output leads to a less than one for-one increase in demand.
  • 6. Deriving the IS Curve  Deriving the IS Curve (a) An increase in the interest rate decreases the demand for goods at any level of output, leading to a decrease in the equilibrium level of output. (b) Equilibrium in the goods market implies that an increase in the interest rate leads to a decrease in output.
  • 7. Properties of IS Curve  Increase/Decrease in autonomous expenditure will shift the IS curve Rightward/Leftward.  There is an inverse relationship between income(Y) and rate of interest(ROI)  The steepness or flatness of the IS curve determine its elasticity -- Steep IS curve: inelastic. -- Flat IS curve: elastic.
  • 8. Equilibrium in the Money Market  Money Market Equilibrium is achieved when the supply of money and demand for money are equal. Ms = Md
  • 9. LM Curve  Depicts equilibrium in the Money market (L = M).  A plot of the equilibrium interest rate for various levels of output or income, within the money market for a given level of the nominal money supply.
  • 10. Deriving the LM Curve  An increase in income leads, at a given interest rate, to an increase in the demand for money. Given the money supply, this increase in the demand for money leads to an increase in the equilibrium interest rate.  Equilibrium in the financial markets implies that an increase in income leads to an increase in the interest rate. The LM curve is therefore upward sloping.
  • 12. Properties of LM Curve  Upward sloping, Y  L  i*  Increase/Decrease in the real money supply shift the LM curve Rightward/Leftward.  The steepness or flatness of the LM curve describes the elasticity or responsiveness of money demand (L) to the nominal interest rate. -- Steep LM curve: inelastic. -- Flat LM curve: elastic. (L=speculative demand for money)
  • 13. Conclusion  IS Curve represents the equilibrium of the goods market.  LM Curve represents the equilibrium of the money market.  The point of intersection of the two curves is the point of equilibrium of both the markets simultaneously.
  • 14. A Presentation By : -  PRATEEK BANSAL  VIVEK RATHI  DEBANKITA PAUL