Aggregate Supply

This model is called the IS-LM model after the two curves that are involved in the model. The IS curve describes equilibrium in the market for goods and services in terms of r and Y. The IS curve is downward sloping because as the interest rate falls, investment increases, thus increasing output. The LM curve describes equilibrium in the market for money. The LM curve is upward sloping because higher income results in higher demand for money, thus resulting in higher interest rates. The intersection of the IS curve with the LM curve shows the equilibrium interest rate and price level.

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. .

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