What is the IS-LM Model? 

The IS-LM model, which stands for “investment-saving” (IS) and “liquidity preference-money supply” (LM) is a Keynesian model that shows how the market for economic goods (IS) interacts with the loanable funds market (LM) or money market.

It is represented as a graph in which the IS and LM curves intersect to show the short-run equilibrium between interest rates and output.

The three external variables in the IS-LM model are liquidity, investment, and consumption.

According to the theory, liquidity is determined by the size and velocity of the money supply.

The levels of investment and consumption are determined by the marginal decisions of individual actors.

The IS-LM graph examines the relationship between output, or GDP and interest rates.

The entire economy is boiled down to just two markets—output and money—and their respective supply and demand characteristics push the economy toward an equilibrium point.