Formation
The model is presented as a graph of two intersecting lines in the first quadrant.
The horizontal axis represents national income or real gross domestic product and is labelled Y. The vertical axis represents the real interest rate, i. Since this is a non-dynamic model, there is a fixed relationship between the nominal interest rate and the real interest rate (the former equals the latter plus the expected inflation rate which is exogenous in the short run); therefore variables such as money demand which actually depend on the nominal interest rate can equivalently be expressed as depending on the real interest rate.
The point where these schedules intersect represents a short-run equilibrium in the real and monetary sectors (though not necessarily in other sectors, such as labor markets): both the product market and the money market are in equilibrium. This equilibrium yields a unique combination of the interest rate and real GDP.
Read more about this topic: IS/LM Model
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