• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Compare and contrast, the assumptions, the predictions and the policy implications of the IS/LM model with those of the New Classical model

Extracts from this document...


There is no universal agreement among economists as to how the economy functions at a macroeconomic level. In stead there are various schools of thought. Theses schools of thought see very different roles for the government in managing various macroeconomic objectives. There are various models and theories which try to elucidate the economy/markets. There are two key markets in which both fiscal and monetary policy operate. The first is the goods market and the; the second is the money market. Each of theses markets can be analysed using the IS-LM model. The goods market, uses the Keynesian injections (investments) /withdrawals (savings) model (IS model). Fiscal policy operates directly in this market. In the case of the money market, the model is the one showing the demand for money (L) and the supply of money (M) and their effects on the rate of interest. Monetary policy operates directly in this market, either by affecting the supply of money or by operating on interest rates. The Investments and savings (IS) curve is based on Keynesian theory of withdrawals and injections. The IS curve is derived from this theory. Figure -1 examines how the IS curve is derived. Figure-1 has two parts. The top part shows the Keynesian injections and withdrawals diagram where we are assuming that savings is the only withdrawals from the circular flow of income, and investments are the only injection. Where the bottom part of the diagram shows the IS curve. This shows all the various combinations of interest rates (r) and national income (Y) ...read more.


As you can see this (REH) assumption is significantly different to that from either the Keynesian or monetarist assumptions, where it uses the means of conjecture derived from past/current information's and experience to rationally predict or forecast inflation, where the Keynesian and monetarist use a approach more derived from the aspects mentioned in their policies that are interdependent where a fall/rise in one aspect will have a consequence on the other etc i.e. For the goods market a fall in interest rates results in a rise in expenditure. The marketing clearing assumption, assumes that the goods market (prices), money Market (interest rates) and the labour market (wages) are all flexible. These flexible prices allow inflation to be controlled, ensuring that natural rates (equilibriums) are established in these markets. Equilibrium is achieved in these markets by controlling/balancing the elements, such as, prices, interest rate and wages. This policy in contrast to the LM and IS policies assume that there is flexibility in the markets, where the fiscal and monetary polices for the IS and LM models assume that that each element in there market (i.e. investments/expenditure in the money market) are interdependent upon each other where their flexibility is limited to one another i.e. investments/ expenditure is interest-sensitive, where by small changes in interest rates mean larger changes in expenditure/ investments. Fiscal policy operates directly in goods market; it is where the government alters the balance between their expenditure and taxation, altering the balance between withdrawal and injections. This allows the government to control aggregate demand. ...read more.


The Keynesians argue that the fiscal policy is the superior than the monetary policy where the new classicists argue the opposite, where in true fact an integration of the policies is altogether better refer to figure-5. It is also argued by Extreme Keynesian that the aggregate supply curve is horizontal up to full employment in the short-run, where a rise in aggregate demand will raise output, without effecting price until full employment is reached. However the new classicists argue against this debating that the aggregate supply curve is vertical in the long run, where output and employment will not be affected from changes in aggregate demand where the only effected element is prices. It is obverse at this point that the Keynesians and new classicists are from opposite's end of the spectrum opposing each other. * John Sloman, Economics, 4th edition, Financial Times Prentice Hall, 2000. Chapter 20.3, page 580-586, IS/LM curves, shifts. Chapter 17, page 497, Fiscal policy. Chapter 19, page 555, Monetary policy. * J. Bradford Delong, Macroeconomics, McGraw Hill. * W.Samuelson & S Marks, Economics, 4th edition, Dryden Press, 2003 Section 11.1, page 271, the new classical model. * Dave hall, Business Studies, 2000, Cpl" Section 8, Page 198, LM and IS models. * Gillian Butler and Freda McManus, Economic policies 2nd edition, Oxford University Press, 2000 * http://www.economist.com- IS-LM models, curves, shifts * http://www.Econmic policies.com- Fiscal and monetary policy * http://www.BSstudies.co.uk - Economic index * http://www.Google.com - New classical model, policies * R.T. Froyen, Macroeconomics, Theories and Polices, Prentice * John Sloman, Economics, 4th edition, Financial Times Prentice hall, 2000. * Nicky Stanton, Economics, 3rd edition, Palgrave masters series, 2000. , page 445, aggregate supply and demand. ?? ?? ?? ?? - 1 - ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our GCSE Economy & Economics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related GCSE Economy & Economics essays

  1. Economics - Classical School of Thought, Keynesian School of Thought, Supply Side School of ...

    interference, they believed free market were the best organizers of economic activity this kind of approach put total reliance on markets. Adam Smith's early work was on this theme, he introduced the naotion of '"Iinvisible Handhand'. " Smith he arguesd that thean invisible hand would organize market and& ensure that they arrives d at an the optimum out come.

  2. Development Theories - Describe the Harrod-Domar model of growth

    A growing industrial sector requiring labour provided the incomes that could be spent and saved. This would in itself generate demand and also provide funds for investment. Income generated by the industrial sector was trickling down throughout the economy. Governments can therefore increase development by encouraging people to leave the

  1. Supply side policy.

    economic and social returns from higher spending on education - but few deny that "investment in education" has the potential to raise the total stock of skills within the work force and improve the employment prospects of thousands of unemployed workers.

  2. The Nature of Macroeconomics

    -a + sY o S = saving o -a = dissaving or survival consumption when Y = 0 o s = MPS o Y = income The Multiplier * Multiplier (k) = mechanism which a change in an injection causes a proportionally greater change in national income * Change in

  1. An Empirical Investigation into the Causes and Effects of Liquidity in Emerging

    Variables found not to be significant, but may be of interest to consider are changes in international interest rates and oil prices. The 3-month US Treasury bill rate was used to capture the effects of external financial developments. It was hypothesised that this rate would affect the cost of new borrowing and the interest charges on existing debt.

  2. What do you Consider the Key Elements of "New Classical" Macroeconomics? What are the ...

    The first economist to challenge the orthodoxy of old Keynesian economic theory, which had dominated macroeconomics since the 1930's, was Milton Friedman. Robert E. Lucas, who went on to become the leading developer of new classical macroeconomics, further developed Friedman's earlier work on new classical theory New classical macroeconomics focuses

  1. Split Votes: A Nation Divided on the Marijuana/Drug Legalization Debate

    Like Mr. Kinsley, she rejects the current set of dogmas on drugs and questions the nation's moral stance. Prohibition, in this article, is described as a hypocritical, ineffective law that the country is morally addicted. She feels people are two-faced in the way they deal with narcotics, legal and illegal.

  2. Economics of European Integration

    will definitely turn to be very beneficial, and cost reductive since most national markets are not familiarised with all generation sources. Analysing the electricity sector market from a macro-economic spectrum, we can argue that it has inelastic demand and inelastic supply too.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work