IS Curve: Equilibrium in Goods Market The IS curve represents combinations of income and interest rates that achieve equilibrium in the goods market, where aggregate demand equals aggregate supply. As interest rates decrease, investment increases due to their inverse relationship; this leads to higher aggregate demand and national income. By plotting these changes across different points (A, B, C), a downward-sloping IS curve is derived.
LM Curve: Equilibrium in Money Market The LM curve illustrates combinations of income and interest rates achieving equilibrium in the money market where money demand matches supply. When incomes rise, people’s need for liquidity grows causing an upward shift in money demand curves while keeping supply constant—this raises interest rates correspondingly. Connecting key points from such shifts forms an upward-sloping LM curve.
General Equilibrium Between Goods and Money Markets Equilibrium between goods (IS) and money markets (LM) occurs at their intersection point on a graph with axes representing income versus interest rate. This simultaneous balance determines overall economic stability by aligning both markets' conditions effectively into one unified framework.