In the IS-LM model, the IS curve and the LM curve are taken into account in a single graph to study the macroeconomic state of a country. In the graph, the point where both curves intersect is the equilibrium point, where the goods market, as well as the money market, are in equilibrium, at an interest rate (i) and GDP (y) . In macroeconomics, we study the situation of the economy of an entire country, and with the IS-LM model, we carry out the analysis based on the situation of the goods and money market to decide the fiscal and monetary policies to take, and evaluate their efects.
The name IS-LM comes from the English words: Investment and savings, which mean investments and savings, and Liquidity preference and money supply, which mean preference for liquidity or money demand, and money supply. Investments are the purchases of goods that contribute to increased productivity, and savings are the amount of money that people and companies decide not to invest, and at the same time, the source of capital to be invested by someone, since the people and companies invest their savings, or the savings of others through banks. The IS curve is the one that shows the combinations of the interest rate and GDP with which the goods market is in equilibrium.
Liquidity preference is literally what people prefer to have in the form of money, or simply money demand, and money supply is the amount of money that the Central Bank decides to put into circulation. The LM curve is the one that shows the combinations of the interest rate and GDP with which the money market is in equilibrium. Now, let's see how the markets for goods and money are related.
For the goods market we have IS, and for the money market we have LM. From the amount of investments I, the level of production and income of a country is defined, that is, the GDP. The GDP reflects the income and consumption of people, which defines the level of demand for money L.
The higher the GDP, the greater the demand for money, and the lower the GDP, the lower the demand. The money supply M is decided by the Central Bank. The relationship between the demand for money and the supply of money, as you know, defines the price of money, that is, the interest rate i.
The interest rate affects the level of investments I and savings S. When the interest rate is high, investments are reduced because it is simply expensive to obtain money, and it encourages saving. On the contrary, when the interest rate is low, investments increase, which again affects GDP, and so on and on and on.
Given the different situations in the goods market, the Government can intervene through expansive or restrictive fiscal policies, managing tax collections and public spending. And in the face of situations in the money market, the Central Bank intervenes through expansive or restrictive monetary policies, managing discount rates, bank legal reserves and open market operations. In short, the IS curve shows the interest rate and GDP combinations with which the goods market is in equilibrium, and the LM curve shows the interest rate and GDP combinations with which the money market is in equilibrium.
is in balance. The IS-LM model shows the combination of the interest rate and the GDP with which both the goods market and the money market are in equilibrium at the same time, and it is used to analyze the macroeconomic state of a country and decide the fiscal and monetary policies to be applied, and then study their effects on the economy. This was the IS-LM model.
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