IS-LM Model of

Income Determination

The IS-LM model is a macroeconomic framework that explains how the

product market and money market interact to determine the equilibrium
level of income and interest rates in an economy.

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by Sujan Kc
Derivation of IS Curve and Product Market
Equilibrium
IS Curve Product Market Equilibrium Factors Shifting IS

The IS curve represents all Occurs when planned aggregate Changes in fiscal policy, consumer
combinations of income and interest expenditure equals the level of real confidence, and investment
rates where the product market is in GDP. The IS curve shows this spending can shift the IS curve.
equilibrium. equilibrium.
Derivation of LM Curve and Money Market
Equilibrium
LM Curve Money Market Equilibrium Factors Shifting LM

The LM curve represents all Occurs when the demand for money Changes in monetary policy and the
combinations of income and interest equals the supply of money. The LM demand/supply of money can shift
rates where the money market is in curve shows this equilibrium. the LM curve.
equilibrium.
General Equilibrium in the Product and Money
Markets
General Equilibrium Adjustment Process Comparative Statics

The intersection of the IS and LM If the economy is not at general Analyzing how the equilibrium
curves determines the equilibrium equilibrium, market forces will drive changes when exogenous factors
level of income and interest rate. it towards the intersection of the IS shift the IS or LM curve.
and LM curves.
Shifts in IS Curve: Effects of Monetary and Fiscal
Policies
Combined Effects
Fiscal Policy
The combined effects of fiscal and monetary policy
Expansionary fiscal policy shifts the IS curve to the depend on their relative magnitudes and directions.
right, increasing output and interest rates.

1 2 3

Monetary Policy
Expansionary monetary policy shifts the IS curve to
the right, increasing output and decreasing interest
rates.
Shifts in LM Curve: Effects of
Monetary and Fiscal Policies
1 Monetary Policy
Expansionary monetary policy shifts the LM curve to the right,
decreasing interest rates and increasing output.

2 Fiscal Policy
Expansionary fiscal policy shifts the LM curve to the left, increasing
interest rates and output.

3 Combined Effects
The combined effects of fiscal and monetary policy depend on their
relative magnitudes and directions.
Equilibrium Determination and
Adjustments
Disequilibrium
If the economy is not at the intersection of the IS and LM curves,
market forces will drive it towards equilibrium.

Adjustment Process
The economy will adjust through changes in output and interest rates
until the IS and LM curves intersect.

New Equilibrium
Once the IS and LM curves intersect, the economy will be in a new
general equilibrium.
Numerical Exercises and Applications
1 Calculating Equilibrium
Solve for the equilibrium level
of income and interest rate
given the IS and LM curves.
2 Analyzing Policy
Changes
Determine the effects of fiscal
and monetary policy changes
on the equilibrium.
3 Real-World Applications
Apply the IS-LM model to
understand macroeconomic
phenomena and guide policy
decisions.