Deriving the IS curve

As the interest rate goes up people start putting more money in the
bank and hence Investment comes down. Now since planned
expenditure E= C + I + G, planned expenditure is reduced. Now
according to equilibrium in keynesian cross E= actual expenditure i.e.
Income. So as the Investment reduces income also reduces. And
Investment reduced because interest rate went up that means
Income (I) is inversely proportional to Interest rate (r).
Deriving the LM curve

For deriving the LM curve we assume that price level is fixed and money supply
is constant. This way Supply of real money balance is fixed in the market it
does not depend on interest rate or income. On the other hand demand for
real money balance in the market increases as Income increases and decreases
as the interest rate increases. Now if the Income level in the market rises
demand curve will shift up as a result equilibrium interest rate goes up.

That means with the increase in interest rate Income rises. This is what is
shown in the LM curve.
Equilibrium in the IS-LM Model

IS curve depicts the relation between income (Y) and interest rate (r) in the
Goods market. Whereas LM curve explains the relation between income and
interest rate in market for real money balance. Intersection point of these two
curves gives us that value of Income for which Interest rate (r) will be the same
in both the markets. All this is concluded under the assumption that fiscal
policy, G and T, monetary policy M, and the price level P as exogenous .
How changes in Fiscal Policy changes the Short-Run Equilibrium
Changes in Government Purchases
Suppose if government expenditure increases by delta G.
The Keynesian cross tells us that, at any given interest rate, this change in fiscal
policy raises the level of income by Delta G/(1 − MPC).Therefore, as Figure 11-1
shows, the IS curve shifts to the right by this amount. The equilibrium of the
economy moves from point A to point B. The increase in government
purchases raises both income and the interest rate.

Changes in Taxes
Suppose if there is a decrease in taxes of DT. The tax cut encourages
consumers to spend more and, therefore, increases planned expenditure. The
tax multiplier in the Keynesian cross tells us that, at any given interest rate, this
change in policy raises the level of income by DT × MPC/(1 − MPC).
How changes in Monetary Policy changes the Short-Run Equilibrium
A change in the money supply changes the interest rate that balances the
money market for any given level of income and, thereby, shifts the LM curve
Consider an increase in the money supply. An increase in M leads to an
increase in real money balances M/P, because the price level P is fixed in the
short run. The theory of liquidity preference shows that for any given level of
income, an increase in real money balances leads to a lower interest rate.
Therefore, the LM curve shifts downward.