30.11.

2016

IS-LM Model
The Derivation of the IS and LM
Curves

Macroeconomics Presentation by Linda Wendsche,

Jana Paffenholz and Isabelle Nehm
Structure
1. What is the IS-LM Model? (Isabelle Nehm)
2. Origin (Jana Paffenholz)
3. Deriving the IS-LM-Model
3.1 The IS-Curve (Isabelle Nehm)
3.2 The LM-Curve (Jana Paffenholz)
3.3 Relation of IS- and LM-Curves (Linda Wendsche)
4. Purpose (Linda Wendsche)
5. Criticism (Linda Wendsche)
6. Sources

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Introduction Origin IS-LM Model Purpose Criticism Sources

1. What is the IS-LM Model?

The IS-LM model is a Keynesian macroeconomics model that shows how the market for economic
goods interacts with the loanable funds market, or money market.

IS - investment savings
LM - liquidity money

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Introduction Origin IS-LM Model Purpose Criticism Sources

2. Origin
- Developed by John Hicks in 1937
- Conference economic society in 1936, presenting papers
to summarize Keynes General Theory
- A paper by Roy Harrad inspired Hicks to come up with
IS-LM theory
- Between 1940-70s leading theory in macroeconomic http://www.hetwebsite.net/he
t/profiles/image/hicks.jpg
analysis

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Introduction Origin IS-LM Model Purpose Criticism Sources

3.1 IS-Curve
Investment-Saving Function
Y = C (Y - T) + I (r) + G

1. I: r I Y
2. S: Y S r

http://analystnotes.com/graph/econo/iscurve.gi 5
f
Introduction Origin IS-LM Model Purpose Criticism Sources

3.1 Government Spending

https://ka-perseus-images.s3.amazonaws.com/7554e6 http://macroeconomicanalysis.com/wp-content/upload
bc9a3e92baf9111e2420893127cd43438c.jpg s/2014/02/IS_1.png
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Introduction Origin IS-LM Model Purpose Criticism Sources

3.2 LM Curve
- Liquidity (Demand for money) - Money supply
- Balance on the money market
- Combinations of interest rates & real income with money market as
equilibrium

r LM

Y
Jana Paffenholz 7
Introduction Origin IS-LM Model Purpose Criticism Sources

3.2 LM curve - Money Supply

- Monetary assets available in an economy at a specific time (currency in
circulation & deposits)
- Exogenous - determined by central bank

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Introduction Origin IS-LM Model Purpose Criticism Sources

3.2 LM curve - Liquidity Preference (Demand)

- Keynesian view: advantage of liquidity
- Hold more money than required for current transactions (unforeseeable
payments)
- Demand Increases as income raises / decreases as income rate increases

M/P = L (r,Y)
- +

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Introduction Origin IS-LM Model Purpose Criticism Sources

3.2 Deriving the LM curve

http://image.slidesharecdn.com/10-4743/95/macroeconomicsch10-36-7
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28.jpg?cb=1168900391
Introduction Origin IS-LM Model Purpose Criticism Sources

3.3 The Relation of IS- and LM-Curves

The IS-Curve The LM-Curve

Y = C (Y - T) + I (r) + G M/P = L (r, Y)

= goods market = money market

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http://www.policonomics.com/is-lm/ http://www.policonomics.com/wp-content/uploads/LM-curve.jpg
Introduction Origin IS-LM Model Purpose Criticism Sources

3.3 The Equilibrium

R* and Y* equilibrium in the goods and the money market

Condition: given price

Actual expenditure = Planned Expenditure

Demand for real money = Supply

http://academlib.com/imag/bef/ahler_macr/image043.jp
g

Production is determined by the demand side 12

Introduction Origin IS-LM Model Purpose Criticism Sources

3.3 The Disequilibrium

Example Point D:

Excess supply in goods market

Excess demand in money market
Real income diminishes
Rate of interest rises

= market tends towards equilibrium Figure 35 (Felderer and Homburg, 1992)

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Introduction Origin IS-LM Model Purpose Criticism Sources

4. Purpose
...and now?

Analyse short-run fluctuations in economic activity

Helps to derive AD curve
AD curve is part of model of AD and AS
used to explain short run effects on national Income

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Introduction Origin IS-LM Model Purpose Criticism Sources

5. Criticism
A lot of exogenous variables
Hicksian-week
Only positive interest rates exist
Capital stock fixed

That diagram is now much less popular with me than I think it still is with
many other people (1976) - John Hicks

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Introduction Origin IS-LM Model Purpose Criticism Sources

6. Sources
Mankiw, G.N. (2015) Macroeconomics. 9th edn. New York, NY, United States: Worth Publishers.

Goodwin, N., Harris, J.M., Nelson, J.A., Roach, B., Torras, M. and Devine, J. (2013) Macroeconomics in context: 2014. 2nd edn. United States: M.E. Sharpe.

Felderer, B. and Homburg, S. (1992) Macroeconomics and new macroeconomics. 2nd edn. Berlin: Springer-Verlag Berlin and Heidelberg GmbH & Co. K.

Heine, M. and Herr, H. (2013) Volkswirtschaftslehre: Paradigmenorientierte Einfhrung in die Mikro- und Makrokonomie. 4th edn. United States: de Gruyter
Oldenbourg.

Hicks, John. IS-LM: An Explanation. Journal of Post Keynesian Economics, vol. 3, no. 2, 1980, pp. 139154. www.jstor.org/stable/4537583.

McCallum, B. and Nelson, E. (1997) Am Optimizing IS-LM Specification For Monetary Policy And Business Cycle Analysis. Available at:
http://www.nber.org/papers/w5875.pdf (Accessed: 29 November 2016).

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