Question

I don’t understand the IS-LM model. Can it be briefly explained

Answer 1

The IS curve represents the pair of interest rate (r) and income level (y) that keeps the product market in equilibrium. In the equilibrium, the planned investment plus government purchases equal planned saving plus tax revenue at that level equilibrium level of income.

For changes in the interest rate, one moves along the IS curve. However, the IS curve shifts due to change in government spending, or tax rate changes or changes in the desire to save.

The LM curve represents the pair of interest rate (r) and income level (y) that keeps the money market in equilibrium with a given level of money supply and a given price level. The LM curve shifts in response to a change in the money supply or change in the price level.