Question: Use IS-LM model to explain the decision of national income and interest rate.

A: When the factors affecting the product market and the money market change, the positions of the IS curve and the LM curve will also change, thus changing the balanced national income and interest rate.

Figure (a) If the IS curve moves to the upper right, the equilibrium national income will increase and the equilibrium interest rate will increase. The factors that cause the IS curve to move to the upper right are: increased investment, increased purchases, decreased savings (thus increased consumption) and decreased taxes. On the other hand, if the IS curve moves to the lower left, the equilibrium national income decreases and the equilibrium interest rate decreases. The factors that cause the IS curve to move to the lower left are: decrease in investment, decrease in purchase, increase in savings (thus decrease in consumption) and increase in tax revenue.

Figure (b) assumes that the IS curve remains unchanged. If the LM curve moves to the lower right, the equilibrium national income will increase and the equilibrium interest rate will decrease. The reasons for the LM curve moving down to the right are: the demand for money decreases and the supply of money increases. On the other hand, if the LM curve moves to the upper left, the equilibrium national income decreases and the equilibrium interest rate increases. The reasons for the LM curve moving to the upper left are: the increase of money demand and the decrease of money supply.

The simultaneous change of IS curve and LM curve will also change the equilibrium national income and equilibrium interest rate.

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