Page 176 - DECO402_Macro Economics

Unit-18: IS - LM Analysis

Part (A) of figure 18.9 shows the monye market balance of different levels of GDP. The high level Notes
of L (demand of money) is analogous to high level of GDP. Part (B) joins the different GDP levels
and interest rates which keeps the equality between demand of money and supply of money.
Part (A) of figure 18.9 shows the monye market balance of different levels of GDP. The high level
of Md is because of high level of GDP. Part (B) joins the different GDP levels and interest rate and
gives LM Curve. On OY level of GDP (in part B), the interest rate is Or where L = M (Part A). The
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combination of OY level of GDP and Or interest rate gives the point B in part B. In part B, as the
GDP level rises from OY to OY , there is rise in demand of money which increases money curve
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upward from L to L and the rate of similar interest (in part A) become Or on increasing from Or.
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The combination of actual GDP OY and interest rate Or gives point C in part B. Similarly, as the
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actual GDP level falls from OY to OY , then the shifting downward of money curve i.e., on being L
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to L , the interest rate becomes Or on reducing from Or. The actual GDP OY and interest rate Or
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gives point A in part B. On joining the A, B, C etc. actual GDP and these combinations of interest we
(in part B) get the LM Curve. Therefore this curve shows the combinations of GDP and interest rates
which makes the demand of money and supply of money equal with each other. It’s contained is the
balance in money market.
The money market will be imbalanced when demand of money is not equal to supply of money. Such
points are situated either the right or left to LM Curve. For example, in figure 18.9 (B), point K shows
that combination of actual GDP and interest rate where the demand of money is greater than supply
of money, (L > M). Similarly, in figure 18.9 (A), point L which is situated on the left of LM Curve,
shows that combination of actual GDP and interest rate where the supply of money is greater than
demand of money, (M > L). Therefore, any point on right of LM Curve shows the imbalance in that
money market where demand of money, is greater than supply of money and any point on left of LM
Curve shows the imbalance in that money market where demand of money, is greater than supply of
money and any point on left of LM Curve shows the imbalance in that money market where supply
of money, is greater than demand of money.
Slope of LM Curve

The slope of LM Curve is upward from left to right
which shows the positive relationship between actual
GDP and interest rate. The mean of high level of
actual GDP is the high interest rate and the mean of
low level of actual GDP is the low interest rate. As
the GDP level rises demand of money increases. On
given supply of money, the high demand GDP money
means the high interest rate. With the fall of actual
GDP, interest rate falls. Low GDP means low demand
of money. If supply of money is given, then the low
demand of money means low interest rate.
The steepness and flatness of LM Curve depends on
the senstivity of money demand from the change
of actual GDP and the senstivity of interest rate
because of change in demand of money. If the Figure 18.10
proportion of demand of money is greater than the change in actual GDP, then LM Curve should be
steeper, and If the proportion of demand of money is less than the change in actual GDP, then LM
Curve should be flatter. If the interest rate responsiveness is less than change in demand of money,
then LM Curve should be steeper and if is greater then LM Curve should be flatter.

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