Explain IS-LM equilibrium and discuss the relative effectiveness of monetary and fiscal policy.

1. 1 · Introduce the model. Hicks and Hansen combined the goods market (IS) and the money market (LM) to find Y and r together.
2. 2 · Derive the IS curve. Lower r → more investment → higher Y via the multiplier, so IS slopes down. Example: Y = 3,500 − 100r.
3. 3 · Derive the LM curve. Higher Y → more money demand → higher r for fixed money supply, so LM slopes up. Example: Y = 3,000 + 100r.
4. 4 · Draw the equilibrium and shifts. [Diagram: IS and LM crossing at E (r = 2.5%, Y = 3,250); IS shifting right; LM shifting right]
5. 5 · Fiscal policy. IS right: r and Y rise; crowding out (example: Y rises 250 instead of 500).
6. 6 · Monetary policy. LM right: r falls, investment and Y rise (example: r 1.5%, Y 3,350).
7. 7 · Effectiveness cases.
   • Vertical LM: monetary strong, fiscal weak
   • Liquidity trap: fiscal strong, monetary weak
   • Slope of IS matters too
8. 8 · Sri Lankan link and conclusion. CBSL rate cuts lower borrowing costs for firms; heavy government borrowing can crowd out private investment. The best results come from a coordinated policy mix.

Scoring tip: Draw separate diagrams for the fiscal and monetary shifts so each movement in r is clear.