Question

Derive the equations for IS and LM curves. Specify the parameters of the model. Explain how the levels of equilibrium output and interest rate are influenced by changes in these parameters.

17 Oct 2021
Answer :
Word Count : 1098

The IS curve represents the combination of interest rates and output (GDP) at which the goods market is in equilibrium, while the LM curve represents the combination of interest rates and output at which the money market is in equilibrium.

The IS curve is derived from the goods market equilibrium condition, which states that the sum of desired investment (I), government spending (G), and net exports (NX) must equal total output (Y):

I + G + NX = Y

where I is the level of investment spending, G is the level of government spending, NX is the difference between exports and imports, and Y is the total level of output or GDP.

The LM curve is derived from the money market equilibrium condition, which states that the supply of money (M) must equal the demand for money (L):

M = L

where M is the supply of money and L is the demand for money. The demand for money is a function of the nominal interest rate (i) and output (Y).

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