IS/LM model facts for kids

The IS/LM model is a way that economists show how different parts of the economy work together. It helps us understand the link between interest rates (how much it costs to borrow money) and the total amount of goods and services an economy produces. This model is a key tool in Macroeconomics, which is the study of the economy as a whole.

The model looks at two main parts:

• The market for goods and services (where things are bought and sold).
• The money market (where money is borrowed and lent).

When these two parts are balanced at the same time, it's called "general equilibrium." This is the point where the IS curve and the LM curve meet on a graph.

What is the IS Curve?

The "IS" in the IS curve stands for Investment and Saving. This curve shows all the points where the amount of money people want to save is equal to the amount of money businesses want to invest. When interest rates are lower, businesses are more likely to borrow money and invest, which can lead to more goods and services being produced.

What is the LM Curve?

The "LM" in the LM curve stands for Liquidity preference and Money supply. This curve shows all the points where the amount of money people want to hold (their "liquidity preference") is equal to the total amount of money available in the economy (the "money supply"). When interest rates are higher, people might prefer to put their money in the bank to earn more, rather than holding onto it as cash.

How the Model Works

The IS/LM model helps us see how big economic decisions, like government spending or changes in the money supply, can affect interest rates and the overall economy.

• Fiscal policy involves the government changing its spending or taxes. For example, if the government spends more, it can shift the IS curve.
• Monetary policy involves the central bank changing the money supply or interest rates. For example, if the central bank increases the money supply, it can shift the LM curve.

By looking at how these curves move, economists can predict how these policies might impact the economy's output and interest rates.

Images for kids

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  IS curve represented by equilibrium in the money market and Keynesian cross diagram.

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  A robot thinking about economics.