Page 153 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes IS Injections = Leakages.
In the LM function, L symbolizes liquidity preference, i.e. demand for money. M symbolizes
money supply. LM symbolizes equality of demand for money and supply of money.
LM Demand for money = Supply of money
IS-LM then stands for simultaneous equality of injections and leakages, and of demand for
money and supply of money. Equality of injections and leakages determines national output,
i.e., product market equilibrium. Equality of demand for money and supply of money determines
money market equilibrium. In this way IS-LM signifies simultaneous equilibrium both in the
product market and money market.

9.1 The Two Market Equilibrium

The IS-LM model emphasises the interaction between the goods and the financial markets.
The Keynesian model looks at income determination by arguing that income affects spending,
which, in its turn, determines output (GNP) and income (GNI).

Hicks and Hansen add the effects of interest rates on spending, and thus income and the
dependence of the financial markets on income. Higher income raises money demand and thus
interest rates. Higher interest rates lower spending and thus income spending, interest rates and
income are determined jointly by equilibrium in the goods and financial markets.

Figure 9.1: Basic IS–LM Model

Self Assessment

State whether the following statements are true or false:
1. The IS-LM model stresses the interaction between the goods and the financial markets.
2. Higher income raises money demand, which in turn leads to a decline in interest rates.

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