IS-LM Model

Numerical Example

C = 0.8 Yd
Yd =Y-t
t=0.25
I=900-50i
G=800
L=0.25-62.5i
M/P=500

C = 0.8 Y
Yd =Y-t
t=0.25
I=900-50i
G=950
L=0.25-62.5i
M/P=500
d

1. What is the equation that

describes IS curve?
2. What is the general
definition of IS curve?
3. What is the equation that
describes LM curve?
4. What is the general
definition of LM curve?
5. What are the equilibrium
levels of income and
interest rate?
6. What is the level of g ?
7. How much increase in
income would be in G
increases by 100, in
presence of asset markets.
8. Why is the difference?

IS
IS represents goods markets
equilibrium i.e. Y=AD where Y is
output or income and AD=C+I+G
Y=0.8(1-0.25)Y+900-50i+950
Y=1700+0.6Y-50i
0.4Y=1850-50i
0.4Y+50i=1850 (IS equation)

LM
LM equation represents the money
markets equilibrium i.e. where
supply of money is equal to demand
for money M/P=L
500=0.25Y-62.5i (LM equation)
So we have two equations and two
unknowns. To find equilibrium level of
Y and I would need to solve these
simultaneous equations.

Equilibrium i
0.25Y-62.5i=500 (1)
0.4Y+50i=1850 (2)
Multiply (1) by digit 1.6 to make it
0.4Y-100i=800 (1)
Subtract eq.(2) from (1)
0.4Y-100i=800
-0.4Y-50i=-1850
-150i=-1050 so i is = 7

Equilibrium Y

Putting i=6 in equation (1)

0.25Y-62.5i=500
0.25Y-62.5(7)=500
0.25Y-437.5=500
0.25Y=500+437.5
0.25Y=937.5
Y=3750

Exercise
put i=6 in eq. (2) and check the
results for Y
It should be 3500!

Equilibrium Y

0.4Y+50i=1850
0.4Y+50(7)=1850
0.4Y+350=1850
0.4Y=1500
Y=3750
Difference 3750-3500=250
g =2.5
Increase in Y should have been
2.5*150=375
Reason: due to increase in interest rate