The islm model-finance Essay Example | Topics and Well Written Essays - 1750 words

The islm model-finance - Essay Example In the article Sir John constructed a diagram and a system of equations that represent the goods market and money market equilibrium conditions. Eventually this IS-LM model has become a famous framework for teaching, policy analysis and econometric modelling for both closed and open economies (Dimand 324). Mishkin points out that Keynes considers the total quantity demanded of an economy’s output (or aggregate output that is equivalent aggregate income) is the sum of four types of spending: (1) Consumer expenditure (C) – the total demand for consumer goods and services; (2) Planned investment spending (I) – the total planned spending by businesses on new physical capital (machines, computers, raw materials, factories, etc.); (3) Government spending (G) – the spending by all levels of government on goods and services (government workers, red tape, aircraft carriers, etc.); (4) Net exports (NX) – the net foreign spending on domestic goods and services, equal to exports minus imports (536). Aggregate demand (Yad), according to Keynes, is: Yad = C + I + G + NX and when the total quantity of output supplied (aggregate output produced) Y equals quantity of output demanded Yad: Y = Yad, so it is possible to say that equilibrium occurs in the economy (Mishki n 537). So, the Keynesian framework enables economists to analyse how aggregate output depends on changes in its constituents: autonomous consumer expenditure, planned investment spending, government spending, net exports and taxes as well. Hicks suggested his interpretation of the Keynesian model, taking into consideration three aggregate markets (money, capital and goods) (156). Hicks asserted that â€Å"in the short period the market of labour as well as price changes do not play a significant â€Å"active† role, so the model can be introduced as follows (Vercelli 4-5): where L is the aggregate demand for money (equal to