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IS/LM model

The IS/LM model was used from 1936 onwards to summarize Keynesian macroeconomics. It can be presented as a graph of two intersecting lines in the first quadrant.

The abscissa represents national income[?] and is labelled Y. The ordinate represents the interest rate, r. The IS schedule is drawn as an downward-sloping curve. The LM schedule is a upward-sloping curve. The point where these schedules intersect represents a short-run equilibrium[?] in the real and monetary sectors.

The IS schedule is a locus of points[?] of equilibrium in the "real" economy. Given expectations about returns on investment, every level of income and interest rates will generate a certain level of investment. Income is at the equilibrium level for a given interest rates when the savings consumers choose to make out of that income equals investment. A higher level of income is needed to generate a higher level of savings at a given interest rate. This helps generate the downward slope of the IS schedule.

The Keynesian hypothesis is that deficit spending[?] is like a lower savings rate. An increased deficit by the national government shifts the IS curve to the right.

LM summarizes monetary equilibrium.

LM curve drawn for given money supply

The IS/LM model was born at the Econometric Conference held in Oxford during September, 1936. Roy Harrod[?], John R. Hicks, and James Meade[?] all presented papers describing mathematical models attempting to summarize John Maynard Keynes' General Theory of Employment, Interest, and Money. Hicks, who had seen a draft of Harrod's paper, invented the IS/LM model. He later presented it in "Mr. Keynes and the Classics: A Suggested Reinterpretation" (Econometrica, April 1937).

Extension to labor market. Don Patinkin[?], Franco Modigliani insist requires sticky or rigid prices or money wages.

Keynesian vs Monetarism - relative slopes

Hicks later agreed missed important points in Keynes. Presents real and monetary sectors as separate, Keynes attempted to transcend this. Equilibrium model, ignores uncertainty. Shift in IS or LM curve will cause change in expectations. Other curve will shift. Keynes post-GT finance affect will cause interaction between curves. What about threat of bankruptcy when wages and prices fall?



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