Editing Keynesian economics (section)

====<span id=islm>The IS–LM model</span>====
[[File:Keynesislm.svg|class=skin-invert-image|thumb|IS–LM plot]]

Hicks showed how to analyse Keynes' system when liquidity preference is a function of income as well as of the rate of interest. Keynes's admission of income as an influence on the demand for money is a step back in the direction of classical theory, and Hicks takes a further step in the same direction by generalizing the propensity to save to take both ''Y'' and ''r'' as arguments. Less classically he extends this generalization to the schedule of the marginal efficiency of capital.

The [[IS–LM model|IS-LM model]] uses two equations to express Keynes' model. The first, now written ''I'' (''Y'', ''r'' ) = ''S'' (''Y'',''r'' ), expresses the principle of effective demand. We may construct a graph on (''Y'', ''r'' ) coordinates and draw a line connecting those points satisfying the equation: this is the ''IS'' curve. In the same way we can write the equation of equilibrium between liquidity preference and the money supply as ''L''(''Y'' ,''r'' ) = ''M̂'' and draw a second curve – the ''LM'' curve – connecting points that satisfy it. The equilibrium values ''Ŷ'' of total income and ''r̂'' of interest rate are then given by the point of intersection of the two curves.

If we follow Keynes's initial account under which liquidity preference depends only on the interest rate ''r'', then the ''LM'' curve is horizontal.

[[Joan Robinson]] commented that:
<blockquote>... modern teaching has been confused by J. R. Hicks' attempt to reduce the ''General Theory'' to a version of static equilibrium with the formula IS–LM. Hicks has now repented and changed his name from J. R. to John, but it will take a long time for the effects of his teaching to wear off.</blockquote>

Hicks subsequently relapsed.<ref>Richard Kahn, ''The Making of Keynes' General Theory'', pp. 160 and 248.</ref>{{Clarify|date=November 2021}}