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IS-LM Model

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Abbah Daniel
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21 views

IS-LM Model

Uploaded by

Abbah Daniel
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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IS-LM Model

IS-LM Model (Summary)


The IS-LM model is a macroeconomic tool that shows the relationship between interest
rates and output in the goods and money markets.
The IS curve shows the combinations of interest rates and output where the goods
market is in equilibrium.
The LM curve shows the combinations of interest rates and output where the money
market is in equilibrium.
The intersection of the IS and LM curves gives the equilibrium interest rate and level of
output. Shifts in either curve lead to a new equilibrium.
The IS curve slopes downward because a decrease in interest rates boosts investment
spending, which increases output.
The LM curve slopes upward because a higher level of output increases the demand for
money, which drives up interest rates.
The IS-LM model can be used to analyze the impact of macroeconomic policies on the
economy. Fiscal and monetary policies that shift the IS and LM curves, respectively,
lead to new equilibria with different interest rates and output levels.
The model provides a simple framework to understand how the goods, money, and
policy markets interact in the economy.

NOTE
Introduction to the IS-LM model

What is the IS-LM model and why is it important in macroeconomics?

What are the assumptions underlying the IS-LM model?

What are the main components of the IS-LM model?

The IS curve

What is the IS curve and how is it derived?

IS-LM Model 1
What factors determine the position of the IS curve?

How do changes in government spending, taxes, and investment affect the IS


curve?

The LM curve

What is the LM curve and how is it derived?

What factors determine the position of the LM curve?

How do changes in the money supply and interest rates affect the LM curve?

Equilibrium in the IS-LM model

How do we determine the equilibrium level of output and interest rates in the IS-
LM model?

What are the properties of the equilibrium in the IS-LM model?

How does fiscal and monetary policy affect the equilibrium in the IS-LM model?

Extensions and applications of the IS-LM model

What are the limitations of the IS-LM model?

How can we extend the IS-LM model to include other factors, such as exchange
rates or expectations?

How can we use the IS-LM model to analyze macroeconomic phenomena such
as inflation, recession, and international trade?

Practice problems

1. Suppose the government increases taxes, how will this affect the IS-LM model?
Draw a diagram and explain the changes in the interest rate, output, consumption,
and investment.

2. The central bank increases the money supply, how does this affect the IS-LM
model? Draw a diagram and explain the changes in the interest rate, output,
consumption, and investment.

3. In the IS-LM model, what is the relationship between interest rates and investment?
How does this relationship affect the economy during a recession?

IS-LM Model 2
4. Suppose the economy is in equilibrium, with the IS and LM curves intersecting at
point E. If the government increases spending, what happens to the LM curve and
the interest rate?

5. Explain the impact of an increase in government spending on the IS-LM model.


What is the multiplier effect, and how does it come into play?

6. What is the effect of an increase in money supply on the exchange rate? Draw a
diagram and explain the relationship between the money market and the foreign
exchange market.

7. What is the impact of a decrease in the interest rate on net exports in the IS-LM
model? Explain the relationship between interest rates and the exchange rate.

8. Explain the concept of liquidity trap and its implications for monetary policy. How
can policymakers overcome the liquidity trap and stimulate economic growth?

9. Suppose the economy is in a liquidity trap, and the government implements a fiscal
policy to increase spending. Will this be effective in stimulating the economy? Why
or why not?

10. What are the limitations of the IS-LM model? How can we overcome these
limitations?

IS-LM Model 3

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