IS-LM Model: Equilibrium and Curve Shifts Analysis

IS-LM Model Fundamentals

IS Curve Definition

The IS curve represents the combinations of output and the interest rate where the goods market is in equilibrium.

IS Curve Slope Sensitivity

Suppose investment spending is not very sensitive to the interest rate. Given this information, we know that: the IS curve should be relatively steep.

LM Curve Slope Sensitivity

Suppose the demand for money is not very sensitive to the interest rate. Given this information, we know that: the LM curve should be relatively steep.

IS Curve Shifts

The IS curve will shift to the right when which of the following occurs?

• An increase in government spending.

Movement Along the IS Curve

Which of the following occurs as the economy moves leftward along a given IS curve?

• An increase in the interest rate causes investment spending to decrease.

LM Curve Definition

For each interest rate, the LM curve illustrates the level of output where: money supply equals money demand.

LM Curve Shifts

The LM curve shifts to the right when which of the following occurs?

• None of the above. (Not an increase in output, an increase in consumer confidence, an open market sale of bonds by the central bank, or an increase in taxes.)

Consistency with a Fixed LM Curve

Which of the following statements is consistent with a given (i.e., fixed) LM curve?

• An increase in output causes an increase in money demand.

Economy on Both Curves

Suppose the economy is currently operating on both the LM curve and the IS curve. Which of the following is true for this economy?

• Financial markets are in equilibrium.
• Production equals demand.
• The money supply equals money demand.
• The quantity supplied of bonds equals the quantity demanded of bonds. (ALL)

Economy on LM but Not IS

Suppose the economy is operating on the LM curve but not on the IS curve. Given this information, we know that:

• The money market and bond markets are in equilibrium, and the goods market is not in equilibrium.

Economy Off Both Curves

Suppose the current level of output and the interest rate are such that the economy is operating on neither the IS nor LM curve. Which of the following is true for this economy?

• Financial markets are not in equilibrium.
• Production does not equal demand.
• The money supply does not equal money demand.
• The quantity supplied of bonds does not equal the quantity demanded of bonds. (ALL OF THE ABOVE)