What is the IS-LM model?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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This model is a model that is used to show the relationship between interest rates and the real output of goods and services in an economy.  In this model, the horizontal axis shows the value of real Gross Domestic Product.  The vertical axis shows the real interest rate.  On this graph, the IS curve slopes downward from left to right.  "IS" stands for "Investment-Saving."   Basically, this is the demand curve in this model, showing how much money is demanded at a given interest rate.  The LM curve slopes upward from left to right.  "LM" stands for "Liquidity preference-money supply."  This is the supply curve in this model, showing the quantity of money that will be supplied at any given interest rate.

The whole point of this model is to go a step beyond the Keynesian model.  This model brings in a slightly higher level of complexity by showing us the importance of money supply and interest rates in determining macroeconomic activity.


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