IS LM MODEL

PRESENTED BY
VIPUL RANJAN (2238/15)
ROHIT KUMAR(2222/15)
HASIB ALI(2265/15)
RAJAN(2208/15)

CONTENTS
THE GOODS MARKET AND IS RELATION
DERIVING OUTPUT
DERIVING IS CURVE
SHIFTS IN IS CURVE
FINANCIAL MARKET AND LM CURVE
DERIVING LM CURVE
SHIFTS IN LM CURVE
IS LM EQUILIBRIUM
EFFECTS OF MONETARY AND FISCAL POLICIES

ON IS AND LM CURVE

The Goods Market and The IS

Relation
By goods market we mean buying and

selling of goods and services.

Equilibrium of the goods market is
achieved when the production Y, =
demand for goods i.e. Z
THEREFORE THE EQUATION FOR
EQUILIBRIUM BECOMES

Y=C(Y-T)+I +G =>

+G

Z=C(Y-T)+I

DETERMINING OUTPUT
TAKING INTO ACCOUNT THE INVESTMENT

RELATION BECOMES Y=C(Y-T)+I(Y,i)+G

THIS IS OUR IS RELATION
AN INCREASE IN OUTPUT LEADS INCREASE IN
INCOME AND DISPOSABLE INCOME. THIS LEADS
TO INCREASE IN CONSUMPTION
AN INCRESASE IN OUTPUT LEADS TO INCREASE
IN INVESTMENNT
IN SHORT, AN INCREASE IN OUTTPUT LEADDS
TO INCREASE IN DEMAND FOR GOODS
THROUGH ITS EFFECT ON INVESTMENT AND
CONSUMPTION. THIS RELATION B/W DEMAND
AND OUTPUT FOR A GIVEN INTEREST RATE IS
REPRESNTED BY UPWARD SLOPING CURVE ZZ.

DERIVING IS CURVE
its 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 its

assumed that an increase in
output leads to a less than one
for-one increase in demand

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. This is represented by
downward sloping IS curve
(b) Equilibrium in the goods market
implies that an increase in the
interest rate leads to a decrease in
output. Therefore IS curve is
downward sloping

PROPERTIES OF IS-CURVE
An IS curve is Downward Sloping i.e. an

increase in interest rate (i) decreases

output(Y).
Increase in autonomous expenditure
will shift the IS curve Rightward and
vice-versa.
The steepness or flatness of the IS curve
describes the elasticity or responsiveness of C
and I to the nominal interest rate.
-- Steep IS curve: inelastic.
-- Flat IS curve: elastic.

Shifts in IS Curve

For a given interest rate an increase

in taxes(from T toT`) leads

to a decrease in output and shifts
the IS curve to left.
CHANGES IN FACTOR THAT

DECREASES THE DEMAND FOR

GOODS GIVEN INTEREST RATE SHIFT
THE IS CURVE TO THE LEFT.
CHANGES IN FACTORS THAT

INCREASES THE DEMAND FOR GOODS

GIVEN THE INTEREST RATE SHIFTS THE IS
CURVE TO RIGHT.

Financial market and

the
LM-relation

Financial market and the LM relation

The financial market is a broad term

describing any marketplace where trading of

securities including equities,
bonds,currencies,etc.
INTEREST RATE IS DETERMINED BY THE
EQUALITY OF THE SUPPLY OF AND DEMAND
FOR MONEY M=YL(i)
The variable M on the left side Is the nominal
money stock. The right side gives the
demand for money which is a function of
nominal income, and of nominal interest i.
On dividing both sides by P we get
M/P = YL(i)

Deriving the LM Curve

Let the interest be measured

on vertical axis and the real money

be measured on horizontal axis.
Real money supply is given by the
vertical line at M/P and is denoted as M.
For a real income(Y) real demand is a
decreasing function rate. It is drawn
as the downward sloping curve denoted
as M(d)
The equilibrium is at point A where
money demand and interest rate is equal

Properties of 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.
-- Steep LM curve: inelastic.
-- Flat LM curve: elastic.

Shifts in LM Curve due to change in

Money Supply
An increase in money

causes the LM curve

to shift down.

IS LM EQUILIBRIUM
For equilibrium, at any point of time, the

supply of goods must be equal to

demand of goods and supply of money
must be equal to demand of money. Both
IS and LM relation must hold. Together
they determine both output and the
interest rate.
IS: Y = C(Y-T)+I(Y,i)=G
LM: M/P = YL(i)

Two Market Equilibrium

The intersection point of the IS

and LM curve denotes the

equilibrium point between the
two markets.
Equilibrium in the goods market
implies that an increase in the
interest rate leads to a decrease
in output. This is represented by
the IS curve. Equilibrium in
financial market implies that an
increase in output leads to an
increase in the interest rate.
This is represented by LM curve.
Only on point A which is on both
curves are good sand financial
market in equilibrium.

EFFECTS OF FISCAL POLICY ACTIVITY AND

INTEREST RATE ON IS AND LM CURVES
AN INCREASE IN TAXES SHIFTS THE

IS CURVE TO THE LEFT AND LEADS

TO A DECREASE IN THE
EQUILIBRIUM LEVEL OF OUTPUT AND
THE EQUILIBRIUM INTERST RATE.
TAXES DONT APPEAR IN LM
RELATION AND DOES NOT SHIFT LM
CURVE. THE ECONOY MOVES ALONG
THE LM CURVE.
IF THE INTEREST RATE DID NOT
DECLINE THE ECONOMY WOULD GO
FROM POINT A TO POINT D AS IN
FIGURE. AND OUTPUT WOULD BE
DIRECTLY BELOW PONT D.
BECDAUSE OF THE DECLINE IN THE
INTEREST RATE WHICH STIMULATES
INVESTMENT THE DECLINE IN
ACTIVITY IS ONLY TO POINT A.

EFFECT OF MONETARY POLICY

ACTIVITY AND INTERST RATE ON IS
AND LM CURVES
MONEY DOES NOT APPEAR

IN IS CURVE SO MONEY
DOES NOT SHIFT IS CURVE
MONEY APPEARS IN LM
RELATION SO MONEY
SHIFTS LM CURVE.
INCREASE IN MONEY
SHIFTS LM CRVE DOWN
AND VICE VERCA.
A MONETARY EXPANSION
LEADS TO HIGHER OUTPUT
AND A LOWER INTEREST
RATE.

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.
By taking both fiscal and monetary
measures using the IS LM model
recession can be checked out.

Thank You