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Unit 9: General Equilibrium of an Economy: IS-LM Analysis

9.4 Macro Economic General Equilibrium Notes

We will now discuss the joint equilibrium of both markets. For simultaneous equilibrium the
interest rates and income levels have to be such that both the goods and money market are in
equilibrium. The interest rate and level of output are determined by the interaction of money
(LM) and commodity (IS) markets. Both markets clear at E. Interest rates and income levels are
such that the public holds the existing quantity of money, and planned spending (or desired
expenditure) equals output (GNP).

Figure 9.8

9.4.1 Changes in the Equilibrium Level of Income and Interest Rate

Figure 9.9

The equilibrium levels increase and interest rates change when either the IS or LM-curve shifts.
Figure 9.9 shows effect of an increase in autonomous spending (such as autonomous investment)
on the equilibrium level. An increase in autonomous spending shifts IS to the right. Thus,
national income increases and equilibrium level of national income rises. But the increase in
income ( Y) is less than given by the Keynesian investment multiplier [m( )] because interest
rates increase and choke off investment demand. The reason is easy to find out. The increase in
autonomous spending, no doubt, tends to increase the level of income. But an increase in income

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