ISLM analysis

Equilibrium
 Equilibrium in both the goods and money markets
LM
Rate of interest

IS

O
National income
 Equilibrium in both the goods and money markets
LM
Assume that national income
is currently at a level of Y1
Rate of interest

IS

O Y1
National income
 Equilibrium in both the goods and money markets
LM
This gives a rate of
interest of r1 (point a)
Rate of interest

a
r1

IS

O Y1
National income
 Equilibrium in both the goods and money markets
LM
But at r1, national income
is below the goods market
equilibrium level (Y2)
Rate of interest

a b
r1

IS

O Y1 Y2
National income
 Equilibrium in both the goods and money markets
But as income rises, so there
LM
will be a movement up the
LM curve. The interest rate
will rise, thereby reducing
national income below Y2.
Rate of interest

a b
r1

IS

O Y1 Y2
National income
 Equilibrium in both the goods and money markets
LM
Rate of interest

re

IS

O Ye
National income
 ISLM analysis

ISLM analysis of
changes in goods
and money markets
ISLM analysis of changes in the goods and money markets
LM
Rate of interest

r1

IS

O Y1
National income
ISLM analysis of changes in the goods and money markets
LM
A rise in
injections
Rate of interest

r2
r1

IS2

IS1

O Y1 Y2
National income
ISLM analysis of changes in the goods and money markets
LM1 LM2
A rise in the
money supply
Rate of interest

r1

r3

IS

O Y1 Y3
National income
ISLM analysis of changes in the goods and money markets

A rise in both LM1 LM2

injections and
money supply
Rate of interest

r1

IS2

IS1

O Y1 Y4
National income
 ISLM analysis

Deriving an AD curve
from an ISLM diagram
Deriving the AD curve from an ISLM diagram

Rate of interest (r)

LM1

a
r1
IS

Y1
National income (Y)
Price level (P)

P1 a'

Y1
National income (Y)
Deriving the AD curve from an ISLM diagram
LM2
Rate of interest (r)
LM1

b
r2
a
r1
IS

Y2 Y1
National income (Y)
Price level (P)

P2 b'

P1 a'
AD

Y2 Y1
National income (Y)
 ISLM analysis

ISLM analysis of
fiscal and
monetary policy
 ISLM analysis of fiscal and monetary policy
LM
Rate of interest

r1

IS

O Y1
National income
 ISLM analysis of fiscal and monetary policy
LM
Expansionary
fiscal policy
Rate of interest

r2
r1

IS2

IS1

O Y1 Y2
National income
 ISLM analysis of fiscal and monetary policy
LM1 LM2
Expansionary
monetary policy
Rate of interest

r1

r3

IS

O Y1 Y3
National income
 ISLM analysis of fiscal and monetary policy
Expansionary LM1 LM2
fiscal and
monetary policy
Rate of interest

r1

IS2

IS1

O Y1 Y4
National income
 ISLM analysis

Keynesian analysis of
fiscal and
monetary policy
 Keynesian analysis of fiscal and monetary policy
Rate of interest

LM
Expansionary
fiscal policy

IS2
IS1
O Y1 Y2
National income
 Keynesian analysis of fiscal and monetary policy

Expansionary
monetary policy
Rate of interest

LM1

LM2

IS
O Y1 Y2
National income
 ISLM analysis

Monetarist analysis of
fiscal and
monetary policy
 Monetarist analysis of fiscal and monetary policy
LM

Expansionary
Rate of interest

fiscal policy

IS2
IS1

O Y1Y2
National income
 Monetarist analysis of fiscal and monetary policy
LM1 LM2
Expansionary
monetary policy
Rate of interest

IS

O Y1 Y2
National income
Fiscal Policy, the Interest Rate and the IS Curve

The Effects of an
Increase in Taxes
 Monetary Policy, the Interest Rate, and the LM Curve

■ Monetary contraction
(tightening) refers to a decrease
in the money supply.
■ An increase in the money
supply is called monetary
expansion.
■ Monetary policy affects only
the LM curve, not the IS curve.
 Monetary Policy, the Interest Rate, and the LM Curve
The Effects of a
Monetary Expansion