IS-LM model: Derivation of the LM curve

Graphical derivation of the LM curve

Category:

Education

Tags:

• ISLM
• model
• LM
• curve
• derivation

[lostmy1]

i = 1/h(kY - M/P)

where i - interest rate, h - interest sensitivity of the demand for money, k - income sensitivity of demand for money, m - nominal money supply, p - price level

[anunnah]

This guy is wrong. At 1:50 he mention that "in order to get rid of excess demand for money bonds will be sold". But selling bonds is contractionary open market operation (monetary policy), and in that way central bank changeMONEY SUPPLY (vertical line shifts to the left). In his drawing, however, money supply is still there.

[lostmy1]

@anunnah It is not the central bank that sold the bonds but the financial particpants that need money to finance transactions. The MS curve only shifts when the central bank changes its behaviour. It is an exogenous variable.

[lostmy1]

@anunnah Mayby he should have said: "To get hold of money bonds will be sold"

[JonnyHwd]

Learning more from free videos than lecturers you're paying for: Priceless

[azzubhaiya]

@lostmy1 you are right sir

[fazekaslaszlo]

Thank you, great videos!

And of course the presenter is right at 1:50; interest rates will increase as a reaction to a higher level of transactions and with no change in the money supply. AKA "Higher economic activity puts pressure on the interest rate." In deriving the LM curve we don't assume the reserve bank changing monetary policy.

[ZiemerZ]

One thing I want to ask is: What is the algebraic formula for the LM curve?

[Prophetress]

Thank You! I had a hard time understanding the derivation of LM from the textbook. You're a life saver!

[lostmy1]

@anunnah You are a bank and suddenly people begin to withdraw more money because they need to do more transactions. You need to supply these people with more money and to get hold of this money you have to convince the participants who hold passive money to make that money available to you. To do that you sell them bonds at a lower price which increase the rate of return that is the interest rate. And in this process passive balances are converted into active balances.

[anunnah]

@lostmy1 Generally you are right, but participants does not care about excess of money supply. Even more, increase in interest rate is against their interests. Hence, they will never sell bonds in order to get rid of excess money supply. They simply don't care.