Monday, August 24, 2009

IS-LM Curve

The IS-LM model was developed in 1937 by Nobel laureate Sir John Hicks who intended it as a graphical representation of the ideas presented by Keynes in 1936 in his famous book ‘The General Theory of Employment’, “Interest and Money”. In his original IS-LM model Hicks assumed that the price level was fixed at least temporarily. Since Hicks, several generations of economists have worked to refine the IS-LM model, and it has been widely applied in analysis of cyclical fluctuations and macro economics policy, and in forecasting.

Because of is origins the IS-LM model is commonly identified with the Keynesian approach to business cycle analysis. Classical economists who believe that wages and prices move rapidly to clear markets, would reject Hick’s IS-LM model because of the assumption that the price level is fixed. However conventional IS-LM model may be easily adapted to allow for rapidly adjusting wages and prices. The IS-LM model as a frame work for both classical and Keynesian analysis has several practical benefits. First it avoids the need to learn two different models. Second utilizing a single frame work emphasises the large areas of agreement between the Keynesian and classical approaches. Moreover because versions of IS-LM model are so often applied in analysis of the economy and macro economics policy, studying the frame work will help one under stand macro economics problems.

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