is-lm approach
TRANSCRIPT
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.
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