The IS/LM Model

Abstract

This technical note introduces the basic structure of the workhorse IS/LM model for a closed economy (i.e., one that does not engage in international trade). The note derives the core components of the model and derives predictions of effects of fiscal and monetary policy. The price level is assumed to be fixed, and aggregate demand determines output. This note precedes a more comprehensive treatment of aggregate demand and aggregate supply found in subsequent technical notes.

Excerpt

UVA-GEM-0126

Rev. Jul. 29, 2022

The IS/LM Model

Firms, households, and policymakers need to be able to make reasoned judgments about the effects of global events or policy shocks on the economy, but doing so is fraught with opportunities for logical missteps. The IS/LM model is a tool—a logical framework—for thinking about key relationships in the economy. The model maps assumptions about firm and household behavior into predictions for GDP, inflation, interest rates, and unemployment.

This technical note introduces the basic structure of the workhorse IS/LM model for a closed economy (i.e., one that does not engage in international trade). This note, a useful complement for the more in-depth presentation of these models commonly found in an economics textbook, is designed for use in the early stages of a general macroeconomics course.

History, Purpose, and Scope

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Keywords: IS/LM model, goods market, money market, Keynesian economics, macroeconomics