IS and LM curve helps to determine the rate of interest and equilibrium level of income through the equilibrium of money market and goods market. In an open economy, the increase in income level leads to imports of foreign goods rather than spending on domestic products. So, the IS curve in an open economy is steeper.
IS curve in the open economy, represents the goods market, and includes net exports as it is included in aggregate demand in an economy. The determined exchange rate for import and export of goods have an effect in the IS curve.
LM curve represents equilibrium in the money market at different interest rates and income levels.
The intersection of IS and LM curves the rate of interest and income level in the open economy. This relation is illustrated in the figure below:
The figure shows that the negatively sloped IS curve intersects with the positively sloped LM curve at point E. At point E, the equilibrium rate of interest is r, and Y is the equilibrium level of income. The condition leads to the equilibrium of money market and real market or the goods market. Thus, at point E, demand for money and its supply in the market is equal. Along with this, the level of spending is also equal to the level of investment at this point.
