Is, Lm Model And Explanations(In The Form Of An Essay).

1360 words - 5 pages

Essay topic1.Introduction:During the years after World War II, the development of the IS-LM model took several directions. Probably, the most prominent ideas on that theory were expressed in the work of John Hicks called "Mr. Keynes and the Classics". The model expressed in the article was largely based on the works of John Maynard Keynes and became a widely accepted as the alternative framework to standard Keynesian analysis. The IS-LM model is a way of modelling equilibrium in the economy by looking at equilibrium in the goods and services markets (the IS curve) and equilibrium in the money markets (LM curve). Where both these markets are in equilibrium will be the equilibrium level of income. The IS-LM model looks at income against the rate of interest. Hicks used this model to explore the assumptions concerned with investment, savings and the supply and demand for money. The IS-LM model can also be used for the analysis of crowding out of private sector investment caused by government intervention in the economy. In my work I would like to show the detailed mechanism according to which increase in government spending leads to reduction in the private investment and consider the factors by which this economic phenomena is influenced. The main factors of which are elasticities of IS and LM curves and degree of multiplier effect by which IS curve is affected.Main Body:The strength of the model is that it combines events in the financial market with events in the market for goods and services to establish an equilibrium level of overall demand. Two variables - aggregate expenditure and the interest rate adjust to ensure that the demand for investment goods matches the supply of savings, and the demand for money matches the supply. On a graph, (see figure 1), with the interest rate on the vertical axis and the level of income on the horizontal axis, two curves can be plotted. The IS curve slopes down from left to right depicting the set of combinations of interest rate and spending which ensure equilibrium in the investment and savings market. For each level of the interest rate, there is a unique level of income which ensures that investment equals saving. The second curve, LM, plots combinations of interest rates and income levels which ensure the demand for money is equal to the supply. A high interest rate reduces the demand for cash because of the reduction in the cost of bonds and thus may be combined with a high level of national income if equilibrium is to be maintained. This curve usually thus slopes upwards. Where the two curves intersect there is an equilibrium level of both national income and the interest rate (r0,Y0).Figure1.rLMr0IS0Y0 YNext, I would like to consider the effects of crowding out on the IS-LM schedule, which can be caused by government intervention. Crowding out is the process by which an increase in government borrowing displaces private spending. Whereas fiscal policy is the use of taxes and government spending in...

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