Question

3. Explain why it is necessary to use the IS-LM model to simultaneously determine the equilibrium interest rate and real GDP in the goods market and money market. (3 pts.)

Answer 1

In IS-LM model ,we will get two variable, one is equilibrium real GDP and and second is equilibrium interest rate. Real GDP and rate of interst is determined at the intersection of IS and LM curve. At that point goods market and money market both are in equilibrium. In goods market, aggregate demand equals aggregate supply and in money market, supply of money and demand for money are in equilibrium. So in this IS-LM model , savings and investment, propensity to savings and consume,and the supply of money and demand for money play a crucial rule in determination of interest rate and real GDP.