[The General Equilibrium Model]

 The IS-LM model was constructed by J.R.Hicks.

 He highlighted these facts in 1937-one year later after
the publication of Keynes’s The General Theory in
1936 and claimed that unless both product and
monetary sectors reach equilibrium simultaneously, the
economy will not reach a stable general equilibrium.
 Therefore, Hicks developed an analytical model,
known as IS-LM model.
 The term IS marks the abbreviation of I=S
 I stands for investment and S stands for savings, which
are both related to the product sector.
 The term LM is the abbreviation of L=M
 L stands for liquidity i.e., demand for money and M
stands for money supply, both being related to the
monetary sector.
 IS represents the equilibrium condition of the product
sector and LM represents monetary sector equilibrium.
 The purpose of this model is to analyze theoretically
how product and monetary sectors can reach a point of
equilibrium equally.
 To understand the Interdependence and Interrelation of
both the sectors
 For the investment-saving
curve, the independent
variable is the interest rate
and the dependent variable
is the level of income
 The IS curve is drawn as
downward-sloping with the
interest rate (i) on the
vertical axis and GDP
(gross domestic product: Y)
on the horizontal axis
 Decrease in the taxes
shifts IS curve
 For the liquidity preference and money supply curve,
the independent variable is "income" and the dependent
variable is "the interest rate.“
 The LM curve shows the combinations of interest rates
and levels of real income for which the money market
is in equilibrium.
 It is an upward-sloping curve representing the role of
finance and money.
 The LM function is the set of
equilibrium points between
the liquidity preference (or demand
for money) function and the money
supply function (as determined
by banks and central banks).
 Each point on the LM curve
reflects a particular equilibrium
situation in the money market
equilibrium diagram, based on a
particular level of income
 Increase in income leads to higher
money supply that increases
investments (in turn increases the
interest rates) and vice versa for
decrease in income
 Downward shift will be due to increase in stock of
money
 Upward shift will be due to increase in price level.
IS relation: Y  C(Y  T )  I (Y , i )  G
M  Investment =Savings
LM relation:  YL(i )
P
 Liquidity=Money
 The intersection point of the IS
& LM curve denotes the
equilibrium points between the
two markets.
 “A” denotes the single point of
equilibrium of goods and money
market.