A closed-economy IS-LM model. The goods market (IS) and money market (LM) each trace a locus of (Output Y, interest rate r) pairs where that market clears; the economy sits at their intersection.
IS: Y = C(Y) + I(r) + G
C = c0 + MPC(1-t)Y
I = I0 - b·r
→ r(Y) = [c0+I0+G - Y(1-MPC(1-t))] / b
LM: M/P = k·Y - h·r
→ r(Y) = (k·Y - M/P) / h
Fiscal multiplier: k_fiscal = 1 / (1 - MPC(1-t))
- ΔG — a government-spending shock shifts the IS curve outward (right), raising both equilibrium output and the equilibrium interest rate.
- MPC — a higher marginal propensity to consume steepens the multiplier, amplifying how far ΔG pushes output.
- b (investment sensitivity) — how much a rate rise chokes off investment. A low b flattens the IS curve, so the same ΔG causes a bigger rate rise and more crowding-out; a high b keeps rates from moving much.
- Money supply M/P — shifts the LM curve. A looser money supply (higher M/P) lets output expand with a smaller rate rise, softening crowding-out — the classic "monetary accommodation" of fiscal stimulus.
The dashed IS curve marks where the economy would sit with no spending shock (ΔG = 0) at the current MPC and b, so the gap between the dashed and solid curves is the pure demand-side effect of the stimulus. The bar chart shows the resulting composition of GDP: consumption (C), investment (I) and government spending (G) — watch I shrink as G grows, the visual signature of crowding-out.