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IS-LM-model

Theory Of Topic IS-LM-Model

IS-LM-Model is an important economics model in which IS stands for Investments and Savings and LM stands for Liquidity and Money. It is a function of the Keynesian Economic models. It is a macroeconomic theory which shows how the investments and savings are related to the money market. In other words, how the market for goods and services in an economy is affected by the money flow of the economy.

In the IS LM model of macroeconomics, equilibrium strikes when the IS and LM curves intersect. This equilibrium is only short term equilibrium as long term equilibrium strikes when the forces of Aggregate demand ad Aggregate supply meet and intersect (AD-AS model)

The IS LM model is used to show the relationship between interest rates and output as well

The IS LM model is represented by a graph. The graph is made of two curves, the IS curve and the LM curve. The IS curve slopes downward while the LM curve slopes upward. The reason behind the IS curve being downward sloping is simply because investment and consumption always have a negative correlation, i.e. if investment is more, it means the consumption is less and if consumption is more than the investment is less. They are inversely related. In contrary, the LM curve is positively correlated between money demand and interest rate. The quantity of money demanded increases as the interest rate goes higher and also leads to an increase in the total consumption of their income.

This model is not very popular due to its several limitations and several critical objections from economists on the relevance of this model in a real economy. A lot of economists often argue that the method of macroeconomics does not take into account any other factor like inflation, employment or any their important aspects which makes this model a fail. It does not take into account any of the tax laws and policies and current taxation which makes it very limited to use and only theoretical. It is not used practically for analysis other than in books and problems. It does not show actual spending by a household or by an income earner. It also does not take into consideration the internal trade that carried on and the income that is earned and the investments that are put in for that.

It is used mainly for its macroeconomic characteristics and analysis internally. It shows the relationship with aggregate demand partially because of its relation between output and interest rates. It shows that in any economy due to an increase in the interest rate, aggregate demand tends to fall and reduce as more people want to save their money rather than consuming it in order to receive a higher interest rate.

Another important factor in the usefulness is the relationship between interest rates and money supply. When the interest rates falls, money supply tends to increase as people do not kind spending as their savings will not yield a high interest.

Problems Encountered In Solutions To IS LM Model Problems

The IS LM method is quite difficult because so many intertwined relationships that it shows and carries. Students face difficulty in arriving to the conclusion as there may be various and the analyzing might differ from student to student and may not be right in many cases. This causes a discrepancy in results and the student's efforts and time may be considered worthless in the end due to one wrong analysis and leads to a lot of redoing of assignments. Drawing the curve itself has many issues because of the multiple characteristics of each curve. All of this needs to be studied in detail and a proper relationship and curve needs to be formed in order to achieve the right analysis of the problem given. The economic problems have different features and all of them need to be kept in mind in order to achieve the best possible conclusion about the economy. Apart from this the aggregate demand, money supply, savings and investment levels need to be calculated properly in order to lead to the right result for each problem that is given to the students. Keeping all these factors in mind, the problems relating to the IS LM model becomes extremely complicated and challenging for the students.

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