PRESENTATION ON IS-LM MODEL

Presented By:Angana SubediMukti GautamSambridhi

ShresthaPratima

Khadka(GL)Kapil Devkota

Contents

INTRODUCTION

DERIVATION OF IS CURVE•Graphically •Mathematically

DERIVATION OF LM CURVE•Graphically •Mathematically

GENERAL EQUILIBRIUM

SHIFT IN IS CURVE

SHIFT IN LM CURVE

SHIFT IN IS AND LM CURVE AND SIMULTANEOUS EFFECT ON EQUILIBRIUM INCOME

INTRODUCTION The IS is the shorthand expression of the shorthand

equality of investment and saving which represents the product equilibrium,

Where as LM is the shorthand expression of the equality of money demand (L) and money supply (M) and represents the money market equilibrium

The point of intersection of IS and LM curve establishes the equilibrium level of income at which both real and monetary sectors of the economy are simultaneously equilibrium.

The concept of of IS curve and LM curve was developed by Hicks and Hasen,

DERIVATION OF IS CURVE

IS curve is the locus of various pairs of interest rate and income levels at which investment and saving are equal representing product market equilibrium,

Product market is defined as the aggregate market for goods and services ,

Investment curve is negatively sloped with rate of interest and saving is positively sloped with rate of interest.

IS curve is derived by the help of loanable funds theory at each level of income with investment schedule.

S1(Y1)

S2(Y2)S3(Y3)

Y3Y2Y1Saving and Investment National Income

E3

E2

E1

E1

E2

E3

IS

GraphicallyIn

tere

st R

ate

MATHEMATICALLYI= f(r)^-ves = f(r)^+ve

Algebraic deriviation of IS curve

Assumption : c = a+by s = y-c

s=-a+(1-b)y

we know that,for product

market equilibriumS= I

-a+(1-b)y= I –ki y (1-b) =(a+i-ki)

y=1/(1-b)(a+i-ki)……..IS equation

Where,Y= income, A= autonomus consumptioni=rate of interest,K=marginal propensity to investment, b= marginal propensity to consume,

DERIVATION OF LM CURVE LM curve is the locus of various combination of

rate of interest and level of income at which demand for money equals to supply of money representing money market equilibrium,

Money market is the segment of the financial market in which high liquidityasses are traded,

This can be derived by applying liquidity preferences theory of interest developed by KM Keynes

Money supply remains constant (Ms) Demand for money is the sum of demand for

three motives : Precautionary , Transaction and Speculative purpose which is negatively sloped (LP)

Lp +Lt = f(y)^ve Lsp=f(r)^-ve fig after this

LM

E2

Demand and supply of money National income

y1 y2 y3

r3

r1

r2

MS

XX

YY

E1

E3

E1

E2

E3 Inte

rest

Rat

eGraphically

ALGEBRIC DERIVATION

ASUMPTIONS :L=L1 (Lp +Lt)

+L2(Lsp)L1[Lp+Lt] = f(y)^+veL2[Lsp]=f (r)^-veMd = Ky + (I+Li)

L1=f(y) We know that; at money

market eqm,Md =MsKy +(l-li)+ MKy= M –C +LIY=1/K (M-L+RI)…………..LM

EQUATION

Where,L= marginal propensity to demand for moneyLp= liquidity preferences for precautionary motive Lt = liquidity preferences for transaction motive Lsp = liquidity preferences for speculative motiveMd = demand for moneyMs = money supply

GENERAL EQUILIBRIUM

In general equilibrium ,equilibrium rate of interest and equilibrium level at national income are simultaneously determined

when money market and product market are in equilibrium simultaneously the economy attents general equilibrium

Graphically

LM

IS

Y

National income

i1

O

Rate

of i

nter

est

E1

y1 X

SHIFT IN IS CURVE

FACTORS THAT CAUSE THE IS CURVE TO SHIFT

Change in Autonomous Consumer Expenditure Change in Investment Spending Unrelated to the

Interest Rate Change in Government Spending Change in Taxes Change in Net Exports Unrelated to the Interest

Rate

Rate

of I

nter

est

National Income

Graphically

SHIFT IN LM CURVE

FACTORS THAT CAUSE THE LM CURVE TO SHIFT

Change in the Money Supply Reversing this reasoning, a decline in the money

supply shifts the LM curve to the left Autonomous changes in Money Demand

GraphicallyRa

te o

f Int

eres

t

National Income

SHIFT IN IS AND LM CURVE AND SIMULTANEOUS EFFECT ON EQUILIBRIUM

INCOME The coordinated use of monetary and fiscal policy

shifts the IS and LM curves. When expansionary fiscal and monetary policy are

used by government and monetory authority it leads to rightward shift in both IS-LM curve.

When contractionary fiscal and monetory policy are used then it leads to leftward shift in both IS-LM curve.

This effect output, employment, and aggregate demand in the economy.

LM1

LM2

IS1IS2

National income

Rate

of i

nter

est

X

Y

r1

Let us consider a situation where on expansionary mix of monetory fiscal policies is adopted to achieve full employment in the economy. This is illustrated as:

r2r3 A

E

B

0 Y1

YF

LM2

LM1

IS2

IS1

National income

Rate

of

inte

rest

X

Y

r

E2

E1r1

r2

0 Y1YF

Let us take another situation when the economy is at the full employment level of income. This case is illustrated in Figure:

WEAKNESS OF IS-LM MODEL Only a comparative static model, Ignores impact of international trade, Considers price level as exogenous variable, Ignores time lags, Does not include labor market equilibrium in the

analysis, Ignores impact of future expectations.

Queries ??