Examine the mechanics of the 'IS-LM Model' in Keynesian macroeconomics. What does the LM curve represent, and what causes it to shift rightward?

💡 Solution & Explanation

The LM curve represents combinations of interest rates and income levels at which the money market is in equilibrium, where money demand equals money supply. An increase in the nominal money supply by the central bank shifts the LM curve rightward because, at any given level of income, a higher money supply lowers the interest rate required to balance money demand. Conversely, the IS curve represents equilibrium in the goods market where investment equals savings. The intersection of the IS and LM curves determines the short-run equilibrium levels of national income and interest rates. A related macroeconomic tool is the Mundell-Fleming model, which extends the IS-LM framework to open economies with capital mobility.