The Derivation and Shift in IS and LM Curves - Macro Economic Framework

The IS-LM model is a macroeconomic framework that explains the relationship between interest rates and output in an economy. The model is derived from two equations: the IS curve and the LM curve, which represent the equilibrium conditions for goods market and money market respectively.

Derivation of IS and LM Curves

1. IS Curve: The IS curve represents the equilibrium condition in the goods market, where the output (Y) is equal to the aggregate demand (AD). The equation for the IS curve is:

Y = C + I + G + NX

Where, C is consumption, I is investment, G is government spending, and NX is net exports.

2. LM Curve: The LM curve represents the equilibrium condition in the money market, where the demand for money (Md) is equal to the supply of money (Ms). The equation for the LM curve is:

Md/P = L(i,Y)

Where, Md is the demand for money, P is the price level, L is the money demand function, i is the interest rate, and Y is the output.

Shifts in IS and LM Curves

Shifts in the IS and LM curves are caused by changes in the variables that affect the equilibrium conditions in the goods and money markets. The shifts in the curves have a significant impact on the interest rate and output in the economy.

1. Shifts in the IS curve: The IS curve shifts when there is a change in any of the variables that affect the aggregate demand. For example, an increase in government spending or a decrease in taxes will shift the IS curve to the right, indicating an increase in output and interest rates.

2. Shifts in the LM curve: The LM curve shifts when there is a change in any of the variables that affect the demand for money. For example, an increase in the money supply or a decrease in the price level will shift the LM curve to the right, indicating a decrease in interest rates and an increase in output.

Conclusion

In conclusion, the IS-LM model is a macroeconomic framework that explains the relationship between interest rates and output in an economy. The model is derived from the IS and LM curves, which represent the equilibrium conditions for goods market and money market respectively. The shifts in the curves are caused by changes in the variables that affect the equilibrium conditions and have a significant impact on the interest rate and output in the economy.