Hello,
Could someone explain in simple language what they are? I am confused about this concept.
Thx in advance!
Here it is in a nutshell:
The IS curve relates real aggregate income to interest-rate levels: for a given level of real aggregate income, what interest rate is required to ensure that savings equals investment + fiscal balance + trade balance? The curve is then drawn with real aggregate income on the horizontal axis, and equilibrium (real) interest rate on the vertical axis.
The LM curve relates demand for money to supply for money: for a real aggregate income and a given price level, what interest rate is required to balance the demand for money with the supply for money? You don’t draw a single LM curve; you draw one LM curve for each price level, with real aggregate income on the horizontal axis and (real) interest on the vertical axis.
You combine these two to get the aggregate demand curve: start with real aggregate income on the horizontal axis, move up to the IS curve (so you now know the real interest rate), then look at all of the LM curves and pick the one that goes through that (real aggregate income, real interest rate) point: the price level for that LM curve is the price level that corresponds to that level of real aggregate income. Repeat that for all levels of real aggregate income, getting a corresponding price level for each. The plot of real aggregate income (horizontal axis) vs. price level (vertical axis) is the aggregate demand curve.
Voilà!
IS curve on CFAI Text Vol 2 P.224 Exhibit
It is Income (Y) on the horizontal axis. But what is it on the vertical axis ?
Is interest rate the same thing as price level? Interest being the “price” of a loan?
No.
By “price level” they mean something like CPI: the overall price of goods and services.
Thank you so much !
You’re welcome.
Thats really treasure.