The IS curve and the LM curve shift in response to economic activities.
The IS curve shifts outward as a result of increased government purchases,
exogenous increases in investment, decreases in taxes, and exogenous
increases in consumption. The IS curve shifts inward as a result of decreases
in government purchases, exogenous decreases in investment, increases in taxes,
and exogenous decreases in consumption. The LM curve shifts outward as a result
of increases in the money supply and decreases in the price level. The LM
curve shifts inward as a result of decreases in the money supply and increases
in the price level.
The aggregate demand curve can be derived using the IS-LM model.
Recall that the aggregate demand curve relates price level to income and output.
The simplest way to derive the downward sloping aggregate demand curve from the
IS-LM model is to look at the effects of an increase in the price level on
output or income.
When the price level increases, the LM curve shifts inward. An inward shift in
the LM curve results in an intersection of the IS-LM model at a lower level of
output and income and a higher interest rate. When a line connecting the old
price level and the old output and income to the new price level and the new
output and income in the price level and output and income space, the downward
sloping aggregate demand curve appears. In general, from the IS-LM model, it is
clear that aggregate demand slopes downward because as the price level
increases, output and income decrease.
The IS-LM curve is a useful way to incorporate the money market into the logic
driving the aggregate demand curve. By understanding the basics of the IS-LM
model and the three reasons that the aggregate demand curve is downward sloping
as presented under the previous heading, the nature of the aggregate demand
curve is clear. The next step to work through is how shifts of and shifts along
the aggregate demand curve function. In this capacity, the IS-LM model will
become very useful.
Ad-free experience
Study Guides for 1,000+ titles
Full Text content for 250+ titles
No Fear Translations of Shakespeare’s plays (along with audio!) and other classic works
Flashcards
Mastery Quizzes
Infographics
Graphic Novels
AP® Practice & Lessons
Note-taking
Bookmarking
Dashboard
