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The IS-LM model, or Hicks-Hansen model, is a two-dimensional model that shows the relationship between interest rates, output, and the money market in a closed economy. The IS curve represents the equilibrium in the goods market, and the LM curve represents the equilibrium in the money market. For example, an expansionary monetary policy can shift the LM curve to the right, resulting in lower interest rates and higher output.
The IS-LM model can be used to analyze the effects of monetary and fiscal policy. For example, fiscal policy causes changes in the IS curve, which results in changes in the aggregate demand curve. The aggregate demand curve shows the inverse relationship between the price level and the total quantity of goods and services demanded.
Here are some examples of how fiscal and monetary policy can affect the IS-LM model: Expansionary fiscal policy: The government increases spending and/or cuts taxes. This spending is financed by borrowing. Expansionary monetary policy: The money supply increases. This shifts the LM curve to the right, resulting in lower interest rates and higher output.
The IS-LM model was developed by John Hicks in 1937 and was later extended by Alvin Hansen as a mathematical representation of Keynesian macroeconomic theory.
Related Test: Money, Banking, and Financial Markets Practice Test: The IS-LM Model
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