# IS/LM oudated and flawed ? watch

1. I think there's a problem with the IS LM model and how it relates to AD/AS and I 'd like to know your opinions

So we know the LM graph plots the relationship between interest rate i and output Y.

Therefore the correlation exists between the two and would be a MUTUAL correlation if the rules of statistics are to be respected.

So we know that if AD (Y) increases, this causes a rise in demand for money, provided money supply stays constant, this will result in a rise in i and as well as a rise in Y (since the rise in Md will presumably lead to rise in Consumption and or investment).

hence this follows the upward sloping LM curve, and so the reverse should be true: that a rise in i will lead to a rise in Y.

But exactly how does this happen, a rise in i should not lead to a rise in I as, borrowing costs become more expensive, the I equation tends to confirm: I (Y, i), with i being negatively related to I, so i up , I down.

It's true that this model is hopelessly outdated but let's stick within the confines of academia for the moment.

2. no one ?
3. It's new years eve, lighten up.
4. (Original post by Zenomorph)
I think there's a problem with the IS LM model and how it relates to AD/AS and I 'd like to know your opinions

So we know the LM graph plots the relationship between interest rate i and output Y.

Therefore the correlation exists between the two and would be a MUTUAL correlation if the rules of statistics are to be respected.

So we know that if AD (Y) increases, this causes a rise in demand for money, provided money supply stays constant, this will result in a rise in i and as well as a rise in Y (since the rise in Md will presumably lead to rise in Consumption and or investment).

hence this follows the upward sloping LM curve, and so the reverse should be true: that a rise in i will lead to a rise in Y.

But exactly how does this happen, a rise in i should not lead to a rise in I as, borrowing costs become more expensive, the I equation tends to confirm: I (Y, i), with i being negatively related to I, so i up , I down.

It's true that this model is hopelessly outdated but let's stick within the confines of academia for the moment.

1. You said A implies B
2. Then you say because of 1. B implies A

This is wrong logic.
5. (Original post by danny111)
1. You said A implies B
2. Then you say because of 1. B implies A

This is wrong logic.
To be fair the graph says it though. If the graph is upwards sloping, it doesn't matter which variable you increase, the other should also increase, otherwise the graph is not a graph. A graph is not a one way implication, hence the equals sign
6. (Original post by The Polymath)
To be fair the graph says it though. If the graph is upwards sloping, it doesn't matter which variable you increase, the other should also increase, otherwise the graph is not a graph. A graph is not a one way implication, hence the equals sign
The variable on the y-axis is the dependent variable and the variable on the x-axis is the independent variable*.

Your scenario implicitly assumes endogeneity (this is an issue in estimating demand and supply curves, the standard textbook example of endogeneity)

* what i mean is the way the LM curve works is, if there is higher Y there is more money demand but real money supply is fixed, so to lower it again you need a higher r. The logic goes one way here.
7. (Original post by danny111)
The variable on the y-axis is the dependent variable and the variable on the x-axis is the independent variable*.

Your scenario implicitly assumes endogeneity (this is an issue in estimating demand and supply curves, the standard textbook example of endogeneity)

* what i mean is the way the LM curve works is, if there is higher Y there is more money demand but real money supply is fixed, so to lower it again you need a higher r. The logic goes one way here.
Are you sure about this? can I have some sources for your claims because endogenous or not like polymath says graphs are graphs and correlation is correlation, and this is reciprocal.

Anyway, my question (logic) is one way: how does a rise in i (yes use i please, follow the graph for consistency) cause a rise in Y ?
8. (Original post by Zenomorph)
Are you sure about this? can I have some sources for your claims because endogenous or not like polymath says graphs are graphs and correlation is correlation, and this is reciprocal.

Anyway, my question (logic) is one way: how does a rise in i (yes use i please, follow the graph for consistency) cause a rise in Y ?
No.

ps we are not doing maths here, this is not a mathematical graph.
9. Lesson 1: correlation is not causation.
10. This is just a case of finding an equilibrium point.

The ISLM model shows the rate of interest at which the goods markets and money markets come into equilibrium.

(Original post by Zenomorph)
a rise in i should not lead to a rise in I as, borrowing costs become more expensive, the I equation tends to confirm: I (Y, i), with i being negatively related to I, so i up , I down.
Correct, this is why the IS curve is downward sloping.

(Original post by Zenomorph)
So we know that if AD (Y) increases, this causes a rise in demand for money, provided money supply stays constant, this will result in a rise in i and as well as a rise in Y (since the rise in Md will presumably lead to rise in Consumption and or investment).
Correct, this is why the LM curve is upward sloping.

The point at which the two relations meet is the equilibrium.

Its the same as looking at a general supply and demand graph. If price goes up people want less, but if price goes up firms supply more....so is this counterintuitive? No, two things are moving in opposite directions and they will meet at an equilibrium point.

(Original post by Zenomorph)
So we know that if AD (Y) increases, this causes a rise in demand for money, provided money supply stays constant, this will result in a rise in i and as well as a rise in Y

What is causing this rise in AD in your example in the first place?

If you are talking about combining the ISLM and ASAD then the increase in AD will have come from either a shifting out of the IS curve (which will raise interest rates) or a shifting down of the LM curve (which will lower interest rates).

If the increase in AD is being caused by a shifting down of the LM curve then this is a monetary expansion. The money supply is being increased, so its not a case of money supply staying constant.

So I assume you are meaning AD is being increased by a shifting out of the IS curve, which will raise interest rates. The IS curve will intersect the LM curve at a higher interest rate. The ISLM shows the interest rate at which the goods market and money market come into equilibrium. As you have correctly said, when income rises, money demand rises. In the absence of a change in money supply, this means the interest rate that brings the money market into equilibrium will be higher as the interest rate is the price of money that brings money supply into equilibrium with money demand.
11. (Original post by danny111)
No.

ps we are not doing maths here, this is not a mathematical graph.
ps. yes it is, do your homework kid
12. (Original post by MagicNMedicine)
This is just a case of finding an equilibrium point.

The ISLM model shows the rate of interest at which the goods markets and money markets come into equilibrium.

Correct, this is why the IS curve is downward sloping.

Correct, this is why the LM curve is upward sloping.

The point at which the two relations meet is the equilibrium.

Its the same as looking at a general supply and demand graph. If price goes up people want less, but if price goes up firms supply more....so is this counterintuitive? No, two things are moving in opposite directions and they will meet at an equilibrium point.

What is causing this rise in AD in your example in the first place?

If you are talking about combining the ISLM and ASAD then the increase in AD will have come from either a shifting out of the IS curve (which will raise interest rates) or a shifting down of the LM curve (which will lower interest rates).

If the increase in AD is being caused by a shifting down of the LM curve then this is a monetary expansion. The money supply is being increased, so its not a case of money supply staying constant.

So I assume you are meaning AD is being increased by a shifting out of the IS curve, which will raise interest rates. The IS curve will intersect the LM curve at a higher interest rate. The ISLM shows the interest rate at which the goods market and money market come into equilibrium. As you have correctly said, when income rises, money demand rises. In the absence of a change in money supply, this means the interest rate that brings the money market into equilibrium will be higher as the interest rate is the price of money that brings money supply into equilibrium with money demand.

maybe but this still does not address my question:

hence this follows the upward sloping LM curve, and so the reverse should be true: that a rise in i will lead to a rise in Y.

But exactly how does this happen, a rise in i should not lead to a rise in I as, borrowing costs become more expensive, the I equation tends to confirm: I (Y, i), with i being negatively related to I, so i up , I down.
13. (Original post by Zenomorph)
ps. yes it is, do your homework kid
I dont believe this, I'm trying to help you and you act like a ****?

And no, it is not. You should learn some econometrics to understand this.
14. (Original post by Zenomorph)
maybe but this still does not address my question:

hence this follows the upward sloping LM curve, and so the reverse should be true: that a rise in i will lead to a rise in Y.

But exactly how does this happen, a rise in i should not lead to a rise in I as, borrowing costs become more expensive, the I equation tends to confirm: I (Y, i), with i being negatively related to I, so i up , I down.
Remember that output does not just increase due to investment.

In the ISLM an increase in output is one of two things - shift down of the LM, which would be a monetary expansion, or a shift up of the IS.

If its a shift up of the IS then it will be due to:
- fiscal expansion (increase in G)
- an exogenous increase in consumption or investment, that means the IS shifts out for a higher level of Y at all levels of i

In this case it is like a demand curve shifting out. Demand is downward sloping because Q increases as P decreases. But if you have an increase in demand, the whole curve shifts out, meaning at any given level of P, Q is higher. This is what an increase in AD represented by a shift out of the IS would be. At any level of i, Y is higher than before, but still Y will fall as i rises.
15. (Original post by Zenomorph)
hence this follows the upward sloping LM curve, and so the reverse should be true: that a rise in i will lead to a rise in Y.
The ISLM model does not say anywhere that a rise in i will lead to a rise in Y. You must be misinterpreting the model. The LM curve being upward sloping tells you that a higher interest rate will be needed to bring the money market (money supply/money demand) into equilibrium, as Y rises. This is because higher Y means money demand increases so the price of money (i) increases.

The LM curve is basically a set of points at which the money market is in equilibrium. The IS curve is a set of points at which the goods market is in equilibrium. The intersection of ISLM is the point where the goods and money markets are both in equilibrium.

The ISLM model tells you what will happen to Y and i if other things happen:

- increase in government spending (IS shifts out): increase in Y and increase in i
- decrease in government spending (IS shifts in): decrease in Y and decrease in i
- monetary expansion (LM shifts down): increase in Y and decrease in i
- monetary contraction (LM shifts up): decrease in Y and increase in i
16. (Original post by danny111)
I dont believe this, I'm trying to help you and you act like a ****?

And no, it is not. You should learn some econometrics to understand this.
You call this help ? you can't even understand a simple graph and you talk econometrics?

Sure you got GCSE maths ?

LOL
17. (Original post by MagicNMedicine)
The ISLM model does not say anywhere that a rise in i will lead to a rise in Y. You must be misinterpreting the model. The LM curve being upward sloping tells you that a higher interest rate will be needed to bring the money market (money supply/money demand) into equilibrium, as Y rises. This is because higher Y means money demand increases so the price of money (i) increases.

The LM curve is basically a set of points at which the money market is in equilibrium. The IS curve is a set of points at which the goods market is in equilibrium. The intersection of ISLM is the point where the goods and money markets are both in equilibrium.

The ISLM model tells you what will happen to Y and i if other things happen:

- increase in government spending (IS shifts out): increase in Y and increase in i
- decrease in government spending (IS shifts in): decrease in Y and decrease in i
- monetary expansion (LM shifts down): increase in Y and decrease in i
- monetary contraction (LM shifts up): decrease in Y and increase in i
No, you got it wrong, ISLM only explains changes in i or Y via changes in ADAS, as variables within this model they do not initiate changes in each other.

Remember they are policy instruments and not objectives in themselves.
18. (Original post by Zenomorph)
You call this help ? you can't even understand a simple graph and you talk econometrics?

Sure you got GCSE maths ?

LOL
Judging by your answer you have no clue what it even is.

Good luck to you. You'll need it.
19. (Original post by Zenomorph)
No, you got it wrong, ISLM only explains changes in i or Y via changes in ADAS, as variables within this model they do not initiate changes in each other.
You haven't understood what I have said. This is not what I was saying.

(Original post by Zenomorph)
So we know the LM graph plots the relationship between interest rate i and output Y.

Therefore the correlation exists between the two and would be a MUTUAL correlation if the rules of statistics are to be respected.
This is like saying a supply curve plots the relationship between price and quantity, so a correlation exists. Yes - a positive correlation.

But also, a demand curve plots the relationship between price and quantity, so a correlation exists. This time it is a negative correlation.

When there is a correlation like this, for every value of one variable there exists a unique value of the other variable, and the correlation allows you to work that out. So in supply where there is a positive correlation, for every P there is an associated Q, and Q rises as P rises. With demand there is a negative correlation, so for every P there is an associated Q but Q falls as P rises. So when you are looking at an interaction between supply and demand, there will be one unique P,Q combination that satisfies both. This is equilibrium.

The ISLM is the same principle.

IS is going from i to Y. It tells you that as i increases, investment will fall, and as investment influences Y, as i increases, Y falls. So it is downward sloping like a demand curve.

LM is going from Y to i. It tells you that as Y increases, demand for money increases, and so in the absence of changes in money supply, the interest rate that brings the supply and demand of money into equilibrium increases. So as Y increases, i increases. Hence it is upward sloping like a supply curve.

At every value of i, there exists a corresponding value of Y that satisfies equilibrium in the goods market, because investment is usually financed by borrowing and lower interest rates create more investment. That set of equilibriums runs all the way along the IS curve.

At every value of Y, there exists a corresponding value of i that satisfies equilibrium in the supply and demand for money. That set of equilibriums runs all the way along the LM curve.

The goods market and money market will come into equilibrium simultaneously at a unique i,Y combination, just like demand and supply will come into equilibrium at a unique P,Q combination.

Then in the same way as exogenous shifts in demand or supply curves will change that equilibrium point, exogenous shifts in the IS or LM curves will change the equilibrium in the ISLM model.
20. (Original post by danny111)
Judging by your answer you have no clue what it even is.

Good luck to you. You'll need it.

Yeah right, that's hilarious coming someone who can't even read a graph.

I think you'll need even more luck. LOL

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