What is the IS and LM Curve all about?
The IS-LM curve model depicts the interaction between the real goods market (IS curve) and the money market (LM curve) in an economy. It is used to analyze the effects of changes in fiscal and monetary policy on output, interest rates, and the overall equilibrium of the economy.
The IS curve represents the equilibrium in the goods market and shows the combinations of interest rates and levels of output where planned spending (aggregate demand) equals output (aggregate supply). It slopes downward because as interest rates decrease, investment and consumption increase, causing aggregate demand to rise.
The LM curve represents the equilibrium in the money market and shows the combinations of interest rates and levels of income where money supply equals money demand. It slopes upward because as income increases, money demand also increases, leading to higher interest rates needed to equate supply and demand.
The point where the IS and LM curves intersect represents the equilibrium of the goods and money markets simultaneously. Any changes in fiscal policy (government spending and taxes) or monetary policy (central bank's money supply and interest rate policies) will shift the IS or LM curve, affecting the equilibrium position and various economic variables like output, interest rates, and price levels.