Similarly, when investment demand is not very sensitive or elastic to the changes in the rate of interest, the IS curve will be relatively more steep. For instance, growing population requires more investment in house construction, school buildings, roads, etc.

In their view, division of the economy into two sectors — monetary and real — is artificial and unrealistic. Let us first explain how IS-LM model shows the effect of expansionary fiscal policy of increase in Government expenditure on level of national income. By contrast, the LM curve slopes upward, suggesting the quantity of money demanded is positively correlated with the interest rate and with increases in total spending, or income.

If improvement in the velocity of money occurs such that people require less money to conduct all of their transactions, the LM curve will shift right because the opportunity cost of holding money goes down because there is now an alternative.

This implies that rate of interest varies directly with income. Thus, the IS-LM curve model is based on: The negative relationship between interest rate and output is known as the IS curve.

If the economy suffers from inflation, the Government will like to check it. Decrease in aggregate demand will help in controlling inflation. Suppose the investment demand is highly elastic or responsive to the changes in the rate of interest, then a given fall in the rate of interest will cause a large increase in investment demand which in turn will produce a large upward shift in the aggregate demand curve.

With further lowering of the rate of interest to Or2, the planned investment increases to OI2 see panel a. It will be seen from Fig. It will be seen from panel a that at rate of interest Or0 the planned investment is equal to OI0. An increase in the money supply shifts out the LM curve, but cannot further drive down the interest rate.

It will be noticed from Fig. In some versions of the graph, curves display limited convexity or concavity. Any change in these factors will cause a shift in IS or LM curve and will therefore change the equilibrium levels of the rate of interest and income.

On the contrary, if the demand for money or liquidity preference of the people falls, the LM curve will shift to the right. This implies that with expansion in money supply LM curve will shift to the right as is shown in Fig.

A change in money supply causes a shift in the LM curve; expansion in money supply shifts it to the right and decrease in money supply shifts it to the left. This post has shown all of the possible reasons for shifts in the IS or LM curves to occur.

It has been shown by J. This is because, greater demand for money, given the supply of money, will raise the rate of interest corresponding to each level of national income. It should be noted that Government often cuts expenditure to control inflation in the economy.

Following this complete Keynesian model, in the derivation of the IS curve we consider the level of investment and changes in it as determined by the rate of interest along with marginal efficiency of capital. The IS and the LM curves relate the two variables: Y on the horizontal axis. Effect of Fiscal Policy: Roy HarrodJohn R.

This is because Keynes in his simple multiplier model popularly called Keynesian cross model assumes that investment is fixed and autonomous, whereas IS-LM model takes into account the fall in private investment due to the rise in interest rate that takes place with the increase in Government expenditure.What is the 'IS-LM Model' The IS-LM model, which stands for "investment-savings, liquidity-money," is a Keynesian macroeconomic model that shows how the market for economic goods (IS) interacts with the loanable funds market (LM) or money market.

The IS–LM model was first introduced at a conference of the Econometric Society held in Oxford during September Roy Harrod, John R.

Hicks, and James Meade all presented papers describing mathematical models attempting to summarize John Maynard Keynes' General Theory of Employment, Interest, and Money. As reflected by the IS-LM model an expansionary fiscal policy, therefore, increases the interest rate and the level of output in the IS-LM model for a closed economy.

Next we consider the impact of a contractionary fiscal policy. This post goes over the causes of shifts among the IS and LM curves in the IS-LM model. It includes several examples and graphs showing how shifts in the IS or LM curves affect the graph and model.

In the IS-LM model when taxation increases, in short-run equilibrium, in the usual case, the interest rate _____ and output _____. falls; falls In the IS-LM model, the impact of an increase in government purchases in the goods market has ramifications in the money market, because the increase in income causes a(n) ______ in money ______.

The IS-LM model describes the aggregate demand of the economy using the relationship between output and interest rates. In a closed economy, in the goods market, a rise in interest rate reduces aggregate demand, usually investment demand and/or demand for consumer durables.

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