Road to equilibrium in a basic economic model?

Question

I am reading a (macro)economics book which introduces a model of a small, closed economy. Two relations are presented. The IS relation (savings equals investments, or demand equals production) and the LM relation (money supply equals money demand).The book then goes on about what happens in an economy given by this model .... but is the model's equilibrium one that occurs naturally? Is real-life money supply equal to money demand? Is real-life investment equal to savings? My question in short: **why** does the economy converge to these equilibriums?

Answer 1

It might be easiest to take the curves one at a time. If an economy is off the IS-LM curves, there will be a tendency for the economy to move back to equilibrium because the combination of interest rates r and real income Y are unsustainable.  

For the IS curve, if the economy is operating to the right of the curve, that means real income Y is too high for that interest rate r. As a result, the economy is producing too much, thus firms are accumulating unwanted inventory (positive unplanned Investment). That means there is pressure for firms to lower production. This lowers Y until the economy returns to the IS curve. 

If the economy is to the left of the IS curve, Y is too low for that r and thus inventories are shrinking. In this case firms need to increase Investment, increasing Y until the economy returns to the IS curve.

Similar story for the LM curve but this time instead of Y moving, r moves: to the right of the LM curve there is excess demand for money putting upward pressure on interest rates (the price of money). Interest rates will rise so that supply and demand of money are in equilibrium. Vice versa to the left of the LM curve.

Putting it all together, there is a tendency for Y and/or r to adjust so that both the money market and the goods markets are both in equilibrium.