Answer to Question #108080 in Macroeconomics for Harshita

Question

Contrast the policy implications in the classical and keynesian IS-LM model

Answer 1

In the classical concept, the IS-LM model can be used with a certain degree of conventionality, since the classics do not have connected markets. The IS curve should be fairly gentle, since aggregate demand is highly elastic at the interest rate. The LM curve is vertical, fixed at the level of natural output. In this case, the IS-LM model is not a model of joint equilibrium: the same level of income is provided at any interest rate, and the level of natural output is determined by the number of factors of production used.

In the Keynesian concept, the IS curve is steep enough because of all the components of aggregate demand, only investment demand has an interest rate as an argument to its function, and at the same time, the elasticity of investment expenses at the interest rate is small. The LM curve is quite gentle due to the high elasticity of demand for money at the interest rate. From the conditions of joint equilibrium, the most important concept of Keynesian theory is derived - effective demand, which is the determining parameter in the economy. Effective demand - the value of aggregate demand corresponding to the joint equilibrium.

One conclusion is that, thanks to the remarkable Keynesian theory (unlike the classics), the state can regulate economic processes in the country