Question

Analyse and contrast the IS-LM model to the Solow Growth Model

Answer 1

According to the Solow Growth model, the Output in an economy is the function of its capital and labor factors. This model shows the relationship between constant returns to scale and the diminishing returns to the factors of production. Whereas, the IS-LM model exhibits the relationship between the investment in an economy with the savings done by the people. It discusses how the goods in an economy (referred to as IS) is stagnantly connected with he availability of capital or investment (referred to as LM) in the economy.

                             As per the Solow model of economic growth, the expenditure and income in an economy can be accurately represented in the Production Possibility Frontier curve or graph, which shows much the availability of one factor of production impacts the performance and longevity of the other factors of production, primarily the labor and the capital factors in an economy. The IS-LM model on the other hand depicts how the availability of funds in the economy directly impacts or adjuvants the investment of the people in the economy and further impacts the savings of the consumers. This savings then takes the shape of further investment in to the future production process or in the increase of value or utility of the consumers.

It has been interpreted in many economic theories or postulates ,or for that matter been the center of discussion among many medieval and modern economists that the Slow Growth model largely explains or deals with the longer run or the long term effect in the economy, and that the IS-LM model deals in or explains the economic variables and their effects in the short-run or in the shorter time frame. However, both these models, the long run Solow growth model and the Short run IS-LM model have never been put together and examines one over the other in their context, and the proper transition from the short-run to the long-run has never been showcased.

                                               When we place the IS-LM model and the Solow Growth model in their context and compare them and realize that these two models are not separated from the core economic principle and co-relate to each other in many ways. The contradiction over long-run and short-run showcased in the preceding years in only a myth. When the saving increases in a society, it initials results in a recession in the shorter run, but ultimately it will lead to a huge potential of growth in the longer run. Therefore, savings plays a critical role in the overall economic growth of an individual , a firm or in the larger spectrum , of that of a society and its economy. The microeconomic principle pf the IS-LM model is very much in sync with the macroeconomic adjudication of he macroeconomic thought process of the Slow growth model.