Question

Write an essay on how to extract and create an IS-LM  (Keynesian model). Please use your OWN WORDS and graphs!!

Answer 1

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Question:

Answer:

IS-LM is a macroeconomic model that is developed by Mr. John Maynard Keynes in the 1930. This is very useful and widely taken in use by the the central banks and governments globally. This is Very simple and easy to use and understand. Here we will extract and create an IS-LM model.

Here, in IS 'I' stand for  Investment and 'S' stand for Savin, LM stand for Liquidity of Money. IS-LM Model talk about the relation between of goods market and money market through a graph. Here, Investment means the total amount of spending on goods that is not consume at the same time. It is bought for the future interest only, Saving means the amount that is not use for Consumption and keep aside, LM is all the liquid money ( cash, currency, notes or near by money) that is exist in the economy during a specific time period.

Now we understand these factors (IS & LM) with interest rate. We have seen above the meaning of saving, investment and liquidity of money. Investment means the total amount of spending on goods that is not consume at the same time so, at the lower level of interest rate people invest more and vice-versa. Saving means the amount that is not use for Consumption and keep aside so, people save more at higher interest rate and vice-versa. Now we talk about the LM. T the higher rate of interest LM reduce and vice- versa.

IS and LM also affect the economy. Higher the investment means higher the consumption or spending level that boost the total demand in the economy and higher the total demand boost the GDP growth rate and at the same time its reduce the saving level. Here, we have to remember the interest rate and invest have opposite relation, and other hand saving and interest rate move in the same direction.

Now we will understand all these things through a graph.

Here i will draw there graph 1 is the basic graph and other two graphs ( graph 2 and graph 3) show how the IS and LM move with the different situations.

There are the following components of the graph: IS, LM, interest rate and GDP. here will see the relation between all the components. we have also seen the relation between IS with the interest rate and GDP growth rate.

Here, in the graph 1 we are seeing that 'E' is the equilibrium point here, IS and LM Intersept or cross each others where, interest rate is 'i' and GDP is 'y'. investment and interest rate move in opposite direction,saving and interest rate move in the same direction , interest rate and ML move in opposite direction. Lower the interest rate boost investment that boost GDP growth rate but its increase interest rate ( because of expanding GDP). So, it is important to balance it. So, 'E' is the point where the two curves meet, the forces are balanced and the economy is in equilibrium.. (Show in the graph 1).

Now assume economy is facing trouble so government has increase the government spending that will increase the increased the investment . Higher the investment level shift the 'IS' curve upward (from IS to IS1). So, higher the investment level boost the GDP growth rate from 'Y' to 'Y1 but at the same time it will increase the interest rate. (Show in the graph 2).

Now, because the economy in trouble and government try to boost the economy through government spending but its increased the interest rate.  Higher the interest rate will negatively affect the investment and GDP so, the central bank will increase the money supply that will decrease the interest rate that will boost the GDP growth rate. So, LM curve will shift downward from LM to LM1 and GDP will grow from 'Y' to 'Y1'. (Show in the graph 3).

Thank You