Current Events Paper, IS-LM model typically used in macroeconomics

Name

Economics

Instructor Name

11 July 2012

The essay examines at least three publications both online and offline, directly linked to the IS-LM model typically used in macroeconomics. The chief aim of the essay is to analyze one the current economic issues using the IS-LM model.

IS-LM is typically used as an acronym in the macroeconomic theory whereby the IS curve represents investments and savings. The latter refers to the amount that individuals save out of income after incurring their consumption expenditure. In line with this, savings represent the income that is not consumed but rather kept in a bank so as to earn an interest. Economists believe that savings and interest rates are highly correlated. On the other hand, investment refers to the addition to the nation’s physical stock of real capital assets. The LM curve represents the liquidity preference and the money available for investments3.

In short, the IS curve shows combination of interest rates and output that clear the goods in the market during the short run period. This means that the spending by both the government and the consumers equals to the total production in the economy. Consequently, the LM curve demonstrates all combinations of incomes and interest rates that bring about equilibrium between the money supply and the money demand.

The IS-LM curve could be used to analyze the economic problems that face several countries. The writer of the essay examines the economic problems facing Sudan, a country adjacent to Kenya. After a close examination of the market information in Sudan, it was realized that the price levels have of late skyrocketed and thereby forcing the policy makers to device ways of correcting the situation. Due to increased prices of virtually all commodities in the market, there has been a huge deficit in supply thereby bringing a shortage of commodities in the country. As a result of the shortage, both consumer’s and government’s spending have radically increased and the aggregate demand is no longer equal to the total supply.

Economists think that by use of the IS curve, various combinations of interests and outputs can be set so as to bring about an equilibrium between the demand and supply. With increased interest rates, the investment levels are significantly reduced hence the aggregate demand in the country. As a consequence of continuous increase in interest rates, the aggregate demand falls and finally equates to the supply in the economy. In this case, the prices of commodities also fall and consequently, the inflation level1 .

On the other hand, the money stock in the country is quite large and this has in fact, led to high inflation levels in the country. It is surprising that the country’s inflation level stands at 70 percent which has significantly affected the value of the country’s currency. In relation to the US dollar, the country’s currency has really depreciated and economists think that something needs to be done to help reduce the alarming rates of inflation2.

Indeed, the policy makers are pretty sure that the galloping inflation rates will be reduced, if proper economic measures are put in place. In this case, the LM curve model could be very effective in correcting the disequilibrium that subsists between the money supply and money demand. As indicated above, the LM curve is used to show the various combinations of incomes and interest rates. Perhaps, the policy makers in the country need use effective monetary and fiscal policies to help achieve the equilibrium between money supply and money demand4 .

However, the policy makers in Sudan could combat these problems by prudently applying both the fiscal, as well as monetary policies in the country. In line with this, the Sudanese government has imposed measures to curb excess liquidity and at the same time the deficits in the economy. Such measures include increasing the bank interest rates for the borrowers and at the same time encouraging savings so as to reduce the money supply in the economy.

Besides, it is also possible to reduce the money supply, in the economy, by increasing the cash reserve ratio for banks which will inevitably reduce the supply of money available for lending in virtually all commercial banks, in the country.

Further, the Central bank could increase the interest rates which will in turn discourage investments and consequently increase the marginal propensity to save while, on the other hand, lowering the marginal propensity to consume by the residents in the country.

With such measures, the Sudanese GDP in the country will equate to spending by both consumers and the government. On the other hand, the measures will bring about equilibrium in money supply and money demand hence stability in the economy.

Consequently, a stable economy will ensure that investments are increased hence more output in the economy. With increased output, the prices of basic commodities lower hence the living standards in the economy. When the inflation rates reduce, the production costs of the various goods also reduce, and this encourages domestic production thus economic development. In line with this, the surplus commodities could be exported to other countries hence increasing the export revenues and hence the terms of trade within the country. In addition, the Gross National Product increases due to an increase in the net export3.

In conclusion, it is crystal clear that the IS-LM model could be used to indicate the various equilibriums necessary for economic stability. This could be done by using the IS curve that equates production and consumption within the economy as outlined.

Consequently, the LM curve could be used to indicate the desired equilibrium level in money supply and money demand by controlling the incomes and the interest rates prevailing in the economy.

As outlined above, the equilibrium in production and consumption brings about stability in the economy such that all the commodities produced in the economy are demanded by the residents of a country. In addition, it is necessary to control the money supply in the economy so as to curb inflation levels within the economy. This could only be done by ensuring there exists equilibrium between money demand and money supply.

Work Cited

FAO. Inflation in Sudan. 07 02, 2012. www.fao.org/es/esc/prices (accessed 07 13, 2012).

N.a. Air Defence: Aegis gets better. 07 06, 2012. http://www.strategypage.com/htmw/htada/201220705.aspx (accessed 07 13, 2012).

Nordhaus, Samuelson. Economics. New York: McGraw-Hill, 2008.

Weepana, Akila. IS LM Curve. 07 22, 2004. www.wellesley.edu/economics/weerapana/econ213/econ213pdf/lect213-08.pdf (accessed 07 09, 2012).