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IS & LM Models - Macro Economic Framework, Macroeconomics Video Lecture | Macro Economics - B Com

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FAQs on IS & LM Models - Macro Economic Framework, Macroeconomics Video Lecture - Macro Economics - B Com

1. What is the IS-LM model in macroeconomics?
The IS-LM model is a macroeconomic framework that analyzes the interaction between the goods market (IS curve) and the money market (LM curve) to determine the equilibrium levels of income and interest rates in an economy. It was developed by John Hicks and Alvin Hansen in the 1930s and is widely used to understand the impact of fiscal and monetary policies on aggregate demand and output.
2. How does the IS curve work in the IS-LM model?
The IS curve represents the equilibrium in the goods market and shows the combinations of output (Y) and interest rates (r) at which aggregate demand equals aggregate supply. The IS curve slopes downward because a decrease in interest rates stimulates investment and consumption, leading to an increase in output. Conversely, an increase in interest rates reduces investment and consumption, causing a decrease in output.
3. What is the LM curve in the IS-LM model?
The LM curve represents the equilibrium in the money market and shows the combinations of income (Y) and interest rates (r) at which the demand for money equals the supply of money. The LM curve slopes upward because an increase in income leads to higher money demand, which requires higher interest rates to maintain the equilibrium. Conversely, a decrease in income reduces money demand, leading to lower interest rates.
4. How do fiscal and monetary policies affect the IS-LM model?
Fiscal policy, such as changes in government spending or taxes, shifts the IS curve. Expansionary fiscal policy, such as an increase in government spending, shifts the IS curve to the right, leading to higher output and interest rates. Conversely, contractionary fiscal policy, such as a decrease in government spending, shifts the IS curve to the left, resulting in lower output and interest rates. Monetary policy, such as changes in the money supply or interest rates by the central bank, affects the LM curve. Expansionary monetary policy, such as a decrease in interest rates or an increase in the money supply, shifts the LM curve to the right, leading to higher output and lower interest rates. Conversely, contractionary monetary policy, such as an increase in interest rates or a decrease in the money supply, shifts the LM curve to the left, resulting in lower output and higher interest rates.
5. What are the limitations of the IS-LM model?
The IS-LM model simplifies the complex reality of the economy and has several limitations. First, it assumes a closed economy with fixed prices, which may not hold in the real world. Second, it ignores the role of expectations and financial markets in determining aggregate demand and output. Third, it assumes a stable relationship between interest rates and investment, which may not always hold true. Finally, the model does not consider the long-run effects of policies, such as potential shifts in aggregate supply. Despite these limitations, the IS-LM model remains a valuable tool for analyzing short-run macroeconomic fluctuations.
59 videos|61 docs|29 tests
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