This document discusses the effectiveness of fiscal policy in controlling inflation or deflation based on the slope of the IS curve. It explains that fiscal policy will be more effective when the IS curve has a steeper slope (is less elastic) as it will allow a change in fiscal policy to more significantly impact the level of income and interest rates without crowding out private investment. It also discusses how the slope of the LM curve and positions of the IS and LM curves impact the fiscal multiplier.

1. R1 E1
Crowdingoutof private investmentiszero
R2
E0
0 Y0 YF
HOW FAR FISCALPOLICYBE EFFECTIVEIN CONTROLLINGEITHER INFLATION ORDEFLATION?
IS CURVE WITH VERTICALSLOPE:- FISCALPOLICY WILL BE EFFECTIVEIN ACCORDANCEWITH THE
ELASTICITY OFIS OR SLOPE OF IS.GREATER THE SLOPE OF ISi.e.more than inelastic IScurve.More
effectivewillbe fiscal policytochange of the level of income andrate of interest. If the slope of LM
CURVE REMAINS THE SAME.WHEN ISCURVE IS VERTICALTO X-AXISANDSAME . WHEN IS CURVE IS
VERTICAL TO X-AXISAND GOVERNMENT ADOPTSLIBERAL FISCALPOLICY i.e.reductionintax rates
or increase i.e.reductionintax ratesorincrease ingovernmentexpenditure(g) ortransfer
expenditure(tr).IScurve will shift towardsrightdue to increase indisposableincome andAD but
there will be nocrowdingoutof private investment due toincrease inoutof private investment
due to increase indisposableincome andADbutthere will be nocrowdingoutof private investment
due to increase inrate of interest.Investmentwill totally non-sensitive towardsrate of interest.
Investmentwill totallynon-rateof interest. Asa resultthe coefficientof fiscal multiplierwill be
equal tokeynes’investmentmultiplierwill be equal tokeynes’investmentmultiplierandhighest.
IT Makes ik/l=0.
b) IS CURVE WITH STEEP SLOPE :
y lm
r1
r0
IS1
IS0
Crowdingofprivateinvestment
0 level ofincome,outputandemployment X

2. whenISCURVE IS HIGHLY ELASTICOR FLATTER IN SLOPE OR FLATTER IN
SLOPE:-
Y
E1
R1
R0 E0 E2
R crowding
OUTOF Private
Investment.
X
WHEN IS CURVE IS MUCH FLATTER I.E. HIGHLY ELASTICPRIVATE INVESTMENTWILL BE HIGHLY
SENSITIVETO THE RATE OFINTEREST AS A RESULT CROWDINGOUT OFINVESTMENT WILL BE MUCH
BIGGER SOLIBERAL FISCALPOLICY WILL HAVE SMALLER (LITTLE) EFFECT ON THE ECONOMY.
Y
E
R LM
0
Y0 X

3. FISCALPOLICYHAS COMPLETELY INEFFECTIVETO TACKLE THE SITUATION OFDEFLATION AS
PRIVATEINVESTMENTIS SENSITIVETOTHE RATE OF INTEREST.
G= Crowdingoutof private investment.
CHANGEIN THE POSITION OF LM AND IS CURVEAND EFFECTIVENESS OF FISCAL POLICY:-F
LM
CLASSICAL
Y E’’’’ RANGE
R5 e’’’ crowding out
OF
Private Investment
R4
R3 e’
R2 e
R1 e e’ crowdingoutof
private investment
KEYNESIAN RANGE
Y2 Y3 Y4 YF investment.
0 income
Ik/l=0 Fiscal policyisperfectlyeffective.

4. FISCALMULTIPLIER IS BASEDNOT ONLY THE SLOPE OFIS CURVE BUT ALSOON THE SLOPEOF IS
CURVE BUT ALSOON THE SLOPE OFLM CURVE TOO WHICH CAN BE EXPLAINEDWITH THE HELP OF
DIAGRAM. WHEN LM CURVE IS FLAT AND ISMUCH STEEPER THE POWEROF FISCALMULTIPLIER
WILL BE HIGHEST ANDEQUAL TO KEYNES(IK/L=0) WITH FISCALPOLICYTHERE WILL BE NOINCREASE
IN RATE OFINTEREST ANDHENCE NOCROWDINGOUT OF PRIVATEINVESTMENT ONLY LEVEL OF
INCOME,OUTPUT EMPLOYMENT INCREASETHIS KNOWN ASKEYNESIAN RANGE.WHEN LMCURVE IS
OF NORMALSLOPE WITH LIBERALFISCALPOLICY OF THE GOVERNMENT IS CURVE WILL SHIFT
RIGHTWARDS ASA RESULT RATE OF INTEREST INCREASESANDA SMALL CROWDINGOUT OF
PRIVATEINVESTMENT WILL BE JUST EQUAL TO INCREASEIN GOVERNMENT WHICH IS KNOWN AS
COMPLETE CROWDINGOUT PRIVATEINVESTMENTANDTHERE WILL BE ZERO EFFECT OFINCREASE
IN GOVERNMENT ON THE ECONOMY IT IS KNOWN ASCLASSICALRANGE.
G = _ I

6. IS-LM Equilibrium and the Aggregate demand curve:- According to
classical,AS becomes perfectly inelastic at the long run equilibrium of
full employment whereas AD is determinedby quantity of money
(mv).According to classical,people spendwhole oftheir income
either on consumer goods or capital goods and saved nothing(supply
creates its own demand). As the quantity of money increases in the
economy general price level also increases in the same proportionas
AS is perfectly inelastic at the level of full employment and vice-versa
as it clear by the diagram:-
Y AS
P1
P0
P2 AD0
AD
AD”
0 m

7. On the contrary inIS-LMMODEL AS CURVE REMAINSPERFECTLY ELASTICUPTO THE LEVEL OF FULL
EMPLOYMENT ANDBECOMES PERFECTLY INELASTICAT THE LEVEL OF FULL EMPLOYMENT.
ACCORDINGTO THIS MODEL, ECONOMY IS IN THE STATE OF UNDER FULL EMPLOYMENT AT
GENERAL EQUILIBRIUM . HENCE PRICE LEVEL REMAINSCONSTANT TILL THE LEVEL OFFULL
EMPLOYMENT IS ACHIEVEDPROVIDEDTHERE IS PERFECT MOBILITY AMONG THE FACTORSOF
PRODUCTION ASGIVEN IN THE FOLLOWINGDIAGRAM:- LM
R E I=S=L=M
Y AD AS
P
0 Y0 YF X
LEVEL OF EMPLOYMENT

8. IN IS-LMMODEL, AD DEPENDS UPON ALL THOSE FACTORSWHICH DETERMINES THE POSITION OFIS
ANDLM CURVE LIKE INVESTMENT AND GOVERNMENT EXPENDITURE ETC. QUANTITY OFMONEY IS
ONE FACTORAMONG THEM. AD ISDETERMINED BY THE GENERAL EQUILIBRIUM AT WHICH
I=S=L=M AND THIS AD CURVE INTERSECTSAS IS PERFECTLY ELASTICAT WHICH LEVEL OF INCOMEIS
BELOW THE LEVEL OF FULL EMPLOYMENT. HENCE PRICE LEVEL P0 REMAINS CONSTANTTILL THE
LEVEL OF FULL EMPLOYMENT IS ACHIEVED.
EFFECTS ON FISCALPOLICY ON AGGREGATE DEMAND:- THE POLICY RELATED TO TREASURY IS
KNOWN ASFISCALPOLICY i.e.policyrelatedtotaxationandgovernmentspendingorbudgeting.
AFTER 1930’S WORLD WIDE DEPRESSION CLASSICAL THEORY OF INCOME ANDEMPLOYMENT
PROVEDFUTILE TO BRING THE ECONOMIES ON RIGHT TRACK(RAILS).
LORD J.M. KEYNES CAME FORWARDWITH THIS GENERAL THEORY OF EMPLOYMENT, INTEREST AND
MONEY PUBLISHED IN 1936 ANDSUGGESTED GOVERNMENTACTIVEPARTICIPATION AND
INTERVENTION IN ECONOMICACTIVITIESTOMAINTAIN THE LEVEL OF INCOME,OUTPUT,
EMPLOYMENT WITH STABILITY.
FISCALPOLICYAND MONETARY POLICY ARE TWO SUCH WEAPONSWITH THE GOVERNMENTWITH
THE HELP OF THESE OBJECTIVESCAN BE OBTAINED.
Y AD AD1 ADH AS
E2
P0 E0 E1
0 y0 yf X

9. Fiscal policy isthe policyrelatedtofisc(treasury) i.e.Relatedto taxationandgovernmentspending
withthe helpof the fiscal policygovernment canattainpotential level of outputwiththe stability.
Wheneffect of fiscal policyonaggregate demandisexplainedwe assume the effectof monetary
policyconstant.Governmentincurexpendituretopurchase several goodsandservicesfromthe real
marketand alsoincurr expenditureastransferexpenditure astransferexpenditure astransfer
expenditure astransferexpendituretoprovide securitytoitscitizenslike scholarship,oldage
pension,widowallowancesandnatural calamities(i.e.flood,drought,earthquake etc.).ASaresultIS
curve will shift rightwardsorleftwardsasrequiredfor the healthof economy.
EFFECT OF FISCALPOLICY TO CURB DEFLATION:-Duringthe seriousdaysof depressiongovernment
wantsto increase the level of income,outputandemployment tobringout the economyfromthe
clutchesof depression.Forthisgovernmentwill increase itsspendingongoodsandservicesaswell
as itstransferexpenditure.In the otherside itwill curtail tax ratessimultaneouslyasa result
disposable income of the peoplewillincreasewhichwill increase aggregate demand.The profit
marginsof the entrepreneurwillincreasetheywill investmore thanthe +ve multiplierwill work
whichwill increase the levelof income,outputandemploymentbyktimesbutinkeynesianmodel
was calledindeterminate whereasis-lmmodel itwascalledindeterminate whereasis-lmmodelit
was takeninaccount withincrease asa resultrate of interestwilldefinitelyincrease inmoney
supplyisconstant.The marketvalue of a bond will fall.People will investtheirfundsinbonds.There
will be crowdingoutinvestmentwill be lessthanthe governmentspending.Hence itwill have +ve
effectonlevel of income,outputandemploymentwhichcanbe shownwiththe helpof following
diagram:- r
g
r0 A’ B’
(I+G)0 B
I+G (I+G)1 R1 A
(I+G)
( I+G)1 (I+G)0 Y0 Y1 Y1

10. REDUCTION IN TAX-RATES OR TAXES AND SHIFT IN IS CURVE
UPWARDTOWARDS RIGHT
R
A B
( I+G) 0 R0
(I+G)1 R1 A’ B’
A’ B’ IS IS1
I+G (I+G) (I+G) 0 Y0 Y0’ Y1 y1’
(s+t)0
(s+t)1 k(y) k(y)’
I+G=S+T
S+T
INCREASE IN GOVERNMENT EXPENDITURE TELLS ABOUT THE BALANCEDINCOMEWHICH CAN BE
SHOWN WITH HELP OF IS CURVE ANDLM CURVE. IS0 ANDLM CURVE INTERSECT EACH OTHER AT
POINTE0 ANDDETERMINES Y0 LEVEL OF INCOMEWHICH CAN BE SHOWN WITH HELP OF IS CURVE
ANDLM CURVE. IS0 AND LM CURVE INTERSECT EACH OTHER AT POINTE0 ANDDETERMINES Y0
LEVEL OF INCOME. WHEN GOVERNMENTEXPENDITURE IS INCREASEDA NEW IS CURVE IS FORMED.
R0 ISCONSTANTIN THE COMMODITY MARKET DUE TO THE WORKINGOF MULTIPLIER LEVEL OF
INCOME BECOMES Y1. WHEN INCOME STARTSINCREASING(BECAUSEDEMAND FOR MONEY
INCREASESFORTRANSACTION PURPOSES) TILLMONEY MARKET ISIN EQUILIBRIUM. DUE TO WHICH
PRIVATE INVESTMENTREDUCES WITH THE INCREASEIN GOVERNMENT EXPENDITURE.AS A RESULT
OF IT RATE OF INTEREST INCREASESFROMR0 TO R1 WITH THE INCREASEIN LEVEL OF INCOME
FROMY0 TO Y1.

11. LM
Y
1/1-b G
R1 E
R0 E1
IS0
0 Y0 Y1 Y2
P0
0
AD&AS
Y0 Y1 YF X

12. INCREASEIN GOVERNMENT EXPENDITURE TELLS ABOUT THE BALANCEDINCOME WHICH CAN BE
SHOWN WITH HELP OF IS CURVE . IS ANDLM CURVE INTERSECT EACHOTHER AT POINTE0 AND
DETERMINES Y0 LEVEL OFINCOME. WHEN GOVERNMENT EXPENDITUREIS INCREASED A NEW IS
FORMED. R0 IS CONSTANTIN THE MARKET DUE TO THE WORKING OFMULTIPLIER LEVEL OF
INCOME BECOMES(BECAUSEDEMAND FOR MONEY INCREASESFORTRANSACTION PURPOSES) TILL
MONEY MARKET ISIN EQUILIBRIUM. DUE TO WHICH PRIVATEINVESTMENTREDUCES WITH THE
INCREASE(BECAUSEDEMAND FOR MONEY INCREASEFORTRANSACTION PURPOSES)TILLTHE
MONEY MARKET ISIN EQUILIBRIUM . DUE TO WHICH PRIVATEINVESTMENTREDUCES WITH THE
INCREASE IN GOVERNMENTEXPENDITURE. ASA RESULT OF ITS INTEREST INCREASESFROMY0 TO
Y1. Y LM
R1 E1
E
R0 E
IS1
IS0
0 Y0 Y1 Y2 X
Y
AD1 AD2 AD
P0
0
Y0 AD ANDAS y1 y2

13. IS ANDLM CURVE INTERSECT EACH OTHER AT POINTE1, i.e. the commoditymarketandmoney
bothare in equilibrium.Inportion B of the diagram, withthe increase the government
expenditure(G),aggregateDemand(AD) increasesto(AD1).
Workingof GovernmentmultiplierinISLMmodel:- IN IS-LMMODEL, WITH THE INCREASESIN
GOVERNMENT EXPENDITURETHE INCOME MULTIPLIER MANY FOLDS DUE TO THE WORKINGOF
INVESTMENT.IN KEYNESIAN MODEL THE VALUE OF MULTIPLIER DECREASES DUE TO THE
INVOLVEMENT OF MONEY .KEYNESIAN MULTIPLIER IS LIMITED TO ISCURVE WHICH CAN BE SHOWN
WITH THE HELP OFEQUATION:-
K=1/1-b(1-t) --------------------------------------------------------------------------------------(1)
B=mpc t=taxrate
=MPT K=multiplier
With the change in G, IS CURVE SHIFTS UPWARDSOR DOWNWARDSWITH THE CHANGE IN RATE
OF INTEREST.IT IS CALLED IS-LMMULTIPLIER. DUE TO THE CHANGEIN GOVERNMENT EXPENDITURE
IT IS CALLED IS-LMFISCALMULTIPLIER. DUE TO CHANGEIN GOVERNMENTEXPENDITURE IT IS
CALLED IS-LMFISCALMULTIPLIER. IT CAN BE OBTAINEDIS-LMFISCALMULTIPLIER. IT CAN BE
OBTAINEDISLMEQUATIONS AREDIFFERENTATED ASFOLLOWS:-
ISLMEQUATIONS AREDIFFERENTED AS FOLLOWS:-ISCURVETELLS THE VARIOUSCOMBINATIONSOF
Y (INCOME) ANDR (RATEOF INTEREST )ATWHICH EQUILIBRIUM IS ATTAINEDIN THE COMMODITY
MARKET WHICH CAN BE EXPLAINEDWITH FOLLOWINGEQUATIONS:-
Y=C[Y-T(Y)] +I(R)+G---------------------------------------------------------(1)
LM CURVES TELLS THE VARIOUSCOMBINATIONSOFY ANDR AT WHICH EQUILIBRIUM ISATTAINED
IN THE MONEY MARKET WHICH CAN BE EXPLAINEDWITH FOLLOWINGEQUATION:-
M/P0=L(R)+K(Y)
M/P0= QUANTITY OFREAL MONEY SUPPLY .
L(R)=LIQUIDITY PREFERENCEFOR SPECULATIVE.
K(Y)=THE RATIOOF INCOME SPENDFOR LP(LIQUIDITYPREFERENCE FOR PRECAUTIONARYMOTIVE).
THE GOVERNMENT MULTIPLIER IS-LMEQUATIONS DIFFERENTATEDW.R.T.INCOME(y),WE GET
IS EQUATION:------ Y=C[Y- T(Y)]+I(R)+G-----------------------------------------------------------(1)
DIFFERENTIATED W.R.T. Y:-
dy/dy=dc/dy[dy/dy - dt/dy(dy/dy)]+ Di/dy(dr/dy)+dg/dy
dc/dy=bdt/dy=t di/dy=i
dy/dy=b[dy/dy+dt/dy(dy/dy)]+di/dy(dr/dy)+dg/dy

14. ELIMINATE THE DENOMINATORBY FROMBOTH SIDES OF THE EQUATION:-
dy=b(dy-tdy)+i(dr)+dg
dy=bdy-btdy+idr+dg
dy {1-b(1-t)}=idr+dg
dy{1-b(1-t)}=idr+dg
dy {1-b(1-t)}=idr+dg
dy{1-b(1-t)}=idr+dg--------------------------------------------------------------------------(ii)
LM CURVE:-
M/P0= L(R)+K(Y)-------------------------------------------------------------------------------------(iii)
0=ldr+kdy
dr= -k/l dy--------------------------------------------------------------------------------------------(iv)
BY PUTTING THE VALUE OF DR FROMEQ(IV) IN EQ(II),WEGET
DY{1-b(1-b)+ik/l}=dg
Dy/dg=1/1-b(1-t)+ik/l
Accordingto Keynessimple model :-
Kg=dy/dg=1/1-b(1-t)
BUT ACCORDINGTO IS-LMMODEL :-
Kg=1/(1-b(1-t)+ik/l
.
.. keynes’kg> IS-LM
1/1-b(1-t)>1/1-b(1-t)+ik/l
IF LM IS HORIZONTAL TO X-AXISTHEN SIMPLE KEYNES’Kg is equal to IS-LMKg
Y i.e.ik/l=0
r0 E E0 LM
IS IS1

15. R1 E1
R2 E0
0 Y0 Y1

17. IS-LM MODEL :- IS-LM MODEL was propounded by PROFJ.R.HICKS
AND A.H.HANSEN as a modifiedversionof classical model determines
the rate of interest with the real factors i.e. Iand S only whereas
Keynes preassumes interest only monetary phenomenon. Hence it
determines with the help of demand for money i.e. lp and money
supply. Actually classical determines equilibrium incommodity
market whereas Keynes determines equilibrium in money market
alone. Hence it determines interest with the help of demand for
money i.e. lp and money supply. Actually classical determines
equilibrium in commodity market whereas Keynes determines
equilibrium in money market alone. Hence both the models are
incomplete.
Hicks and Hansen in the extended model (IS-LM) determines equilibrium in
both the market i.e. commodity and money market equilibrium
simultaneously.
DERIVATIONOF IS CURVE
While discussing IS curve they assumer(rate of interest)as a
exogenous factor which is determined by money marketi.e.
demand for money and supply for money (lp and Ms)on the basis
of which they have drawnIS curve.
a ( I+G)0 R0 A d
(I+G)1 G R1
I+G (I+G)1 (I+G)0 Y0 Y1 level of income
(S+T)0 c

18. b (S+T)1 K(Y)
IS CURVE is the locusof all equilibriumpointof i ands or(i=s) at variouslevelsof income andrate of
interest.
Explanation:-the levelof income isassumedconstantandris exogenous factordeterminedin
moneymarket.Governmentexpenditure isautonomousi.e.independent to the rate of
interest.hence onlyIisinverse functionof r.I+G=S+T whichisshowninthe diagramwith45
Angle atthe originasthere isgovernmentinterventionineconomicactivities.
ACCORDINGTO CLASSICALS
I+G=S+T(GOVERNMENT EXPENDITURE=TAXESIMPOSED BY THE GOVERNMENT)
I=S Whichis at yo level income giveninthe cportionof the diagram. Now at yo level of income and
ro rate of interestpointA isobtainedinthe D portionof the diagramat which I=S andhere
equilibriumisattainedinthe commoditymarketof the economy.Inthe similarmannerpointbis
attainedat Y1 level of income andr1 rate of interestatwhichI=S byjoiningAB,IScurve isobtained.
IS curve will be effectedwiththe change inIOR G OR SOR T.IF I OR G INCREASEOR SOR T DECREASE
IS CURVE WILL SHIFT UPWARDS TOWARDSRIGHT ANDVICE-VERSA.
r
a G b
(I+G)0 (I+G)0’ R0 A A’
R1 B B’
I+G’ G’
I+G’1
Y0 Y0’ Y1 Y1'
I+G (S+T)0 Level ofincome
(S+T)0’

19. In the same way ISCURVE will shiftrightupwardseitheronincreasingexpenditureupwardseither
on increasingexpenditureordecreasingS+T.
SHIFT IN IS CURVE WITH THE CHANGE IN INVESTMENT
r
a r0 A A’ d
g r1 B
I+G’ g
I+G g’
I+G Y0 Y0’ Y1 Y1
(I+G)1’(I+G)1 ( I+G)0 ‘(I+G)0 45 (S+T) 0
(S+T)0’
(S+T)1
(S+T)1’
S+T b S+T c
In the same way ISCurve will shiftrightupwardseitheronincreasingexpenditure ordecreasingS+T.

20. SHIFT IN ISCURV SHIFT IN IS CURVE WITH THE CHANGE IN INVESTMENT
r
a r0 A A’ d
r1 B B’
I+G’ gb
I+G
I+G Y0 Y0’ Y1 Y1
(I+G)1’(I+G)1 ( I+G)0 ‘(I+G)0 45 (S+T) 0 level of income
(S+T)0’
(S+T)1
(S+T)1’
B c
k=f(y)
S+T
derivationof lmcurve:- LM curve showsthe variouscombination of these level of income andrate
of these level of income andrate of interest atwhichdemandformoneyandsupplyof moneyis
equal.IndeterminingLMcurve,hicksand Hansenassumeslevel of incomeasa exogenous factorfor
moneymarketwhichis determinedbycommoditymarketandM1(Lt+Lp) isa increasingfunctionof
y and Lsp M2=f(r).M/Pis the moneysupplydividedbyprice level isthe real moneysupplywhich
remainsconstantbecause price levelincreasesinequal proportion of level of income.We candraw
LM curve withthe followingdiagram:- r d A CLOCKWISE
c R0 L=M

21. R2 A
R1 B
Lsp liquiditytrap L=M
0 Y1 y0 Y
K(Y)

22. SLOPE OF LM CURVE:- SLOPE OFLM SHIFTS UPWARDS FROMRIGHT TO LEFT . THE SLOPE OFLM
CURVE IS MORE OR LESS DEPENDSUPON THE ELASTICITY OF SPECULATIVEDEMAND FOR MONEY
[Ms=f(r)] at givenrate of interestandthe value of kis more or less. If the elasticityof speculative
demandformoneyat givenrate of interestthenLMcurve will be more elastic.If the value of kis
more or less.If the elasticityof speculative demandformoneyatgivenrate of interestthenlmcurve
will be more elastic.If the value k is more thenlmcurve will be elastic .THE SHAPEOF LM CURVE
IN SPECIALCASES IS GIVEN BELOW:-
1. PERFECTLY INELASTICLMCURVE:- LM CURVE IS PERFECTLY INELASTIC AT R(RATE OF
INTEREST).WHEN RATE OF INTEREST ISHIGH ANDECONOMY ATTAINSTHE SITUATION OF
FULL EMPLOYMENT AT HIGHER RATE OF INTEREST IN THIS SITUATION SPECULATIVE
DEMAND FOR MONEY IS ZERO.
Y LM
Rate of interest

23. PERFECTLY ELASTIC LM CURVE:- WHEN THE RATE OF INTEREST IS VERY LOW THEN SPECULATIVE
DEMAND FOR MONEY IS INFINITE.ATTHIS RATE OF INTEREST THE PEOPLEWILL PREFER TO MONEY
IN CASH IN ORDER TO MAKE INVESTMENTIN BONDSBECAUSE THE RATE OF INTEREST THE PEOPLE
WILL PREFER TO MONEY IN CASHIN ORDER TO MAKE INVESTMENTIN BONDSBECAUSE THE RATE
OF INTEREST ISVERY LOW, THE PRICE OFBONDS WILL BE HIGH (ASTHE RATE OF INTERESTAND
PRICE OFBONDS ARE INVERSELYRELATED) ANDTHEY WILL PREFER MONEY IN CASH FORMAFTER
THE SELLING THE BONDSIN NEAR COMING FUTURE AT HIGHER PRICE ANDVICE-VERSA.THIS
SITUATION OF LM CURVE SHAPE i.e.HORIZONTALTO X-AXIS CAN BE SHOWN WITH THE HELP OF
DIAGRAM:-
R
Liquiditytrap(Lsp) r
LP 0 Y Y1 level of income

24. Equilibrium(simulatneousequilibrium inthe real market):- withthe helpof iscurve andlmcurve
we can determine simultaneousequilibriumincommoditymarketandmoneymarketinthe
economy.We knowthat iscurve,savingandinvestmentremainsinequilibriumatvariouslevelsof
income andrate of interestandat lmcurve demandformoneyandsupply of money and supplyof
remainsinequilibriumatvariouslevels of income andrate of interestandat lmcurve demandfor
moneyandsupply of moneyremainsinequilibriumatvarioussetsof level of income andrate of
interest.The economywill be in equilibriumatvarioussetsof levelof income andrate of interest.
The economywill be andrate of interest.The economywillbe inequilibrium atvarioussetsof level
of income andrate of interest.The economywill be inequilibriumate where isand lmcurve
intersecteachother.Ate boththe marketsi.e.Real marketandmoneymarketare inequilibrium
simultaneouslyaty0 level of income andr0 rate of interest.The equilibriumisknownasgeneral
equilibriumof the economy. IS
Y E I=S=L=M
R
RATE OF INTEREST
0
LEVEL OFINCOME X
IN ORDINARYSITUATION, THE SLOPEIS POSITIVEBUT THE LM CURVE IS TRAPPEDIN LIQUIDITY
TRAP THEN LM CURVE IS PERFECTLY INELASTIC.

25. IN GENERAL REEQUILIBRIUM IN THE ECONOMY BUT WILLIAMBRANSON OPINES THATMONEY
MARKET WE CAN SHOW EQUILIBRIUM MUCH FASTER THAN REAL MARKET. HENCE ECONOMY
ATTAINSGENERAL REEQUILIBRIUM WITH THE HELP OF MONEY MARKET ATTAINSEQULIBRIUM
MUCH FASTER THAN REAL MARKET.HENCE ECONOMYATTAINSGENERAL EQUILIBRIUM WITH THE
HELP OF MOVINGALONG LM CURVE. IFWE ASSUMES THAT MONEY MARKET IS MORE ELASTIC
THAN COMMODITY MARKET WE CAN SHOW THIS PROCESSWITH THE HELP OF FOLLOWING
DIAGRAMFIGURE(1).
AT POINTA MONEY SUPPLY ISMORE THAN Lp(demandformoney).Asaresultrate
of interestwill fall fromr1to r2 at Y1 level of income atr2 investmentwill increase due to+ve
workingof multiplier.The level of income will increase hencerate of interest .THEEQUILIBRIUM IS
KNOWN ASGENERAL EQUILIBRIUM OF THE ECONOMY.
Y
LM LESS ELASTIC
R2
R0
R1
IS HIGHLY
ELASTIC
0 Y1 Y0

26. PROCESSOF REEQUILIBRIUM FROM A STATE OF DISEQUILIBRIUM IN THE ECONOMY:- WHEN
ECONOMY IS IN EQUILIBRIUM IN REAL MARKET AND DISEQUILIBRIUMIN THE MONEY MARKET AND
DISEQUILIBRIUMIN THE MONEY MARKET OR ECONOMY ISIN EQUILIBRIUM IN THE MONEY
MARKET ASWELL AS IN COMMODITY MARKET.
HOW THE EQUILIBRIUM WILL RETAIN THE GENERAL EQUILIBRIUM?
ACCORDINGTO EDWARD SHAPIRO,COMMODITY MARKET WITH THE HELP OFELASTIC PRICELEVEL
ANDMONEY MARKET WITH THE HELP ELASTIC RATE OF INTEREST WILL BE ATTAINED GENERAL
REEQUILIBRIUM IN THE ECONOMY BUT WILLIAMBRANSON OPINESTHATMONEY MARKET
ATTAINS EQUILIBRIUM MUCH FASTER THAN REAL MARKET.HENCE ECONOMY ATTAINSGENERAL
REEQUILIBRIUM WITH THE HELP OFFOLLOWING DIAGRAMFIGURE(1).
Y LM
R2 lesselastic
R0
R1 highly
IS elastic
0 Y1 Y0 X
At pointk,there isdisequilibriuminboth the marketsof the economybutmoneymarketreacts
swiftlyandthe rate of interestwill fall at the same level of income y1uptor againinvestmentwill
increase.Againrate of intereststartsincreasingdue toworkingof +ve multiplier(+k).Asaresultlevel
of income andsavings will alsoincrease till the economy reattainsgeneralequilibriumatE where
the level of income Y0and the rate of interestr0.