Scribd Logo
Upload

Welcome to Scribd!

  • 8 views

    IS and LM Curve

    Uploaded by

    johri1015

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd

    IS and LM Curve

    Uploaded by

    johri1015
    8 views3 pages

    Original Title

    IS and LM curve

    Copyright

    © © All Rights Reserved

    Available Formats

    DOCX, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    8 views3 pages

    IS and LM Curve

    Uploaded by

    johri1015

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 3

    Method of Derivation of the IS and

    LM Curves (With Diagram)


    In this article we will discuss about the method of derivation of the IS
    and LM curves, explained with the help of suitable diagrams.

    (a) Derivation of the IS curve:


    The IS curve is frequently derived graphically with a four-part diagram
    as shown in Fig. 13. Employing simple linear functions, part (a) of Fig.
    13 is a plot of the investment function (the MEI); part (c) plots the saving
    function, part (b) is simply a 45°-identity line; and part (d) plots the
    commodity market equilibrium, or IS curve.

    Picking an initial interest rate level (say, r 0) fixes the level of investment
    (at I0) and, thus, the volume of saving (S0) necessary for equilibrium.
    Given the volume of saving required, the saving function defines the
    level of income (Y0) necessary for equilibrium.
    This establishes one point on the IS-LM schedule. Altering the initial
    interest rate selected by any amount and tracing through the diagram
    counter-clockwise will yield another point on the IS curve. The resulting
    IS curve will slope downward from left to right as shown.

    The slope depends on two factors, viz.:


    (i) Interest-elasticity of investment and

    (ii) The numerical value of the multiplier

    (b) Derivation of the LM curve:


    Making use of Keynes’ original distinction between transactions and
    speculative money demands, the LM schedule is frequently derived
    graphically using the four-part diagram. See Fig 14. The schedule in part
    (b) of the diagram represents transactions demand for money, assuming
    demand to be proportional (with proportionality constant k) to Y.

    The schedule in (c) is simply an identity line that mechanically divides


    the total money supply into transactions and speculative components.
    This part of total money balance (M) not held in one form must be held in
    the other. The schedule in (a) is the LM curve.
    ADVERTISEMENTS:

    Beginning in (d), with a known interest rate (assume it is r 0), the volume
    of speculative demand is defined [M (spec.) 0]. Given the total money supply
    M, that portion not held as speculative balances must be held in
    transaction balances [M0t] as shown in (c).
    The schedule in (b) shows what level of real income (Y 0) must prevail in
    order to get the public to willingly absorb the money available for
    transactions balance in that form. Thus, as we see in (a) for interest rate
    r0, the only possible money market equilibrium value of income is Y 0.
    Should the interest rate rise to r 1, the only possible equilibrium level of
    income would be Y1 as we can see by again starting in (d) and proceeding
    clockwise through our diagram. Thus, the LM curve slopes upward from
    left to right.
    Simultaneous Equilibrium:
    By combining the commodity and money market equilibrium schedules
    (the IS and LM curves) as in Fig. 15, we can see that only one
    combination of r and Y (the combination r 0 and Y0) can simultaneously
    clear both the money and commodity markets.

    That is, given the money supply and demand schedules that underlay the
    LM curve, and the consumption and investment schedules that underlie
    the IS curve, the only possible equilibrium values of r and Y are the
    combination at the IS- LM intersection.

    At any other combination of an interest rate and an income level the


    commodity market or the money market, or both markets, will be in
    disequilibrium. If, for example, the level of income should rise (say to Y 1),
    the rate of interest determined in the money market (r 1) would exceed
    the interest rate that is necessary (r 2) to stimulate sufficient investment
    to make Y1 the equilibrium level of income in the commodity market.

    You might also like