Output Determination in the IS-LM Model

This chapter explains the IS-LM model of John Hicks to understand aggregate demand management. Assuming that wages are sticky and that the price that the business charges is a fixed markup over the wage, a horizontal aggregate supply schedule at the level of prices is fixed in the economy. The Keynesian model is sometimes simplified so as to say it’s an aggregate demand theory of output in the short term, which only works if the assumption of the wage being fixed in the short-term is a realistic wage. Interest rate is very much affected by the policy instruments of aggregate demand, which is indicated by the IS schedule and the LM schedule. There is a focus on aggregate demand, aggregate supply, interest rates, real money supply and the determinants of demand for money, as well as the role of banks.

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