What is the difference between the LM and IS curves?

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Expert Solution

Investment/saving (IS) curve: IS curve refers to a variation of the income-expenditure model that incorporates market interest rates (demand), thus represents all combinations of income (Y) and the real interest rate (r) in a way that the market for goods and services is in equilibrium. It is downward sloping because when the interest rate declines, investment rises, thus increasing output.

Liquidity-money (LM) curve: LM represents the total sum of money available for investing (supply). It provides the combinations of income and the interest rate for which the desired liquidity or demand for money will equal the money supply and thus for which the domestic economy of the nation is in asset or stock equilibrium. It is upward sloping because higher income leads to more demand for money, hence leading in higher interest

Thus, IS curve demonstrates the equilibrium in the goods market, is defined. On the contrary LM curve demonstrates the equilibrium in the money market. Under a fixed exchange rate regime, the IS curve is fixed and under a floating exchange rate regime, the IS curve is steeper

Rahul Sunny answered 2 years ago

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