Money Market Equilibrium (IS-LM model)
IS- LM MODEL1. Introduction:
Keynesian framework of various variables such as investment, nationalincome, rate of interest, demand for and supply of money are interrelated and mutuallyinterdependent and can be represented by the two curves called the IS-LM curves. In this modelindicates that, how the level of national income and rate of interest are jonitly determined by thesimultaneour equilibrium in the two interdependent goods and money markets. Now, this modelhas become a standear tool of macroeconomics and the effects of monetary and fical policies.
2. The derivation of the IScurve( Goods market equilibrium):
The IS curve relates differentequilibrium levels of national income with various rates of interest. i.e., a full in the rate of interest, the planned investment will increase which will cause an upward shift in aggregatedeman function(C+I) resulting in goods market equilibrium at a higher level of national income.
3. Reason for downward slope;
a. the elasticity of the investment demand curve. b. the size of the multiplier.(Marginal propensity to consume).
4. The derivation of the LM curve (Money market equilibrium):
The demand for moneydepends upon income and rate of interest.
Md= L (Y,r)
Md-demand for moneyL-functionY-incomer-rate of interest
5. Reson for upward slope:
a.the responsiveness of demand for money (liquidity preference) tothe changes in income. b. the elasticity or responsiveness of demand for money.
The IS and LM curves relate the two variables such as, imcome, the rateof interest. Income and the rate of interest are determined togerher at the point of intersection iscalled market equilibrium.
7.IS-LM Model – Advantages
a. Monetary policy described in terms of real interest rates namely.,Realism, Simplicity & coherence.
b.It is also explain the intervention by the government in the market.
8. IS_LM Model-Disadvantages:
a. It is based on the assumption that the rate of interest is quite flexible, that is, free to vary and not rigitdly fixed bythe central bank of a country. If the rate is interst is quite infliexible, then the appropriate adjustment is not possible. b. It is too artificial and over-simplified.