What it means
Hicks developed the IS-LM model in 1937 to explain the ideas in John Maynard Keynes's General Theory in a clear diagram. Hicks drew the picture so that students and policymakers could see the argument at a glance.
The model has two curves: IS shows combinations of interest rates and output where investment equals saving, and LM shows combinations where money demand equals money supply. Where the two curves cross, the goods market and the money market are in balance.
The diagram helps explain how government spending or a change in the money supply can shift output and interest rates, and it became a standard teaching tool for decades. The model also shows why monetary and fiscal policy can work together or pull in opposite directions.
Hicks also gave accountants and economists a famous definition of income. Hicksian income is the maximum amount a person or business can consume in a period and still be as well off at the end as at the start.
In other words, income is what you can spend without making yourself poorer. This idea matters for business because it separates true profit from simply eating into capital.
A company that pays out dividends while letting its equipment wear out has not earned the profit it reports. The definition underlies ideas such as depreciation, capital maintenance and the treatment of unrealised gains.
He is also remembered for Hicksian demand, which describes how consumers adjust purchases when prices change while holding their level of satisfaction constant. It separates the income effect from the substitution effect and is used in price and tax analysis.
The idea is central in welfare economics, where it helps measure how much a price change really costs consumers. Like all models, IS-LM is a simplification.
It ignores inflation expectations and assumes fixed prices, and later models have refined it. Hicks himself questioned some of its uses, but the basic framework remains a useful teaching device.
In practice
Real-world examples.
Example
An accountant reviews a small company's profit and notices that machinery has worn out without any replacement being set aside. Using the Hicksian idea of income, she asks the owner to reduce the dividend so the business remains as well off as before. The owner is reluctant but agrees after seeing the figures.
Example
A policy analyst uses an IS-LM diagram to show how a rise in government spending could raise output but also push up interest rates. She explains the result to ministry colleagues using the two intersecting curves. The picture makes the trade-offs easier to discuss.
Example
A student in a tax course learns that a rise in the value of shares held but not sold counts as a gain in wealth under the Hicksian view. Tax rules may still treat it differently, which prompts a discussion about fairness. The class agrees that the definition of income is a policy choice as much as a technical one.
Formula
Calculation
Hicksian income = Consumption + Change in real wealth
Suppose a family spends $60,000 during the year, and its real wealth (assets minus liabilities, adjusted for inflation) rises from $200,000 to $220,000.
Change in real wealth = $220,000 - $200,000 = $20,000
Hicksian income = $60,000 + $20,000 = $80,000
The family's Hicksian income is $80,000. It could have spent $80,000 without ending the year poorer than it started, but it chose to spend $60,000 and save the other $20,000. The same logic applies to a company: profit is only fully earned once the business has set aside enough to keep its capital intact.Case study
Seen in the real world.
This is an illustrative story about a fictional company. Ashdown Printers, an invented printing firm, reported a profit of $300,000 and paid it all out as dividends.
The new finance manager, Omar, applied the Hicksian test. He noticed that the presses had lost $120,000 in value through wear that had not been replaced, so the company was effectively $120,000 poorer.
By his measure, the firm's true income was $180,000. Omar proposed setting aside funds for new equipment before paying dividends, and in this illustrative story the owners agreed after seeing that the earlier payouts had slowly drained the business. The company now reviews its asset replacement plan every year.
Watch out
Common mistakes.
- Treating IS-LM as a precise forecasting tool. It is a simplified picture of how markets interact. Real economies are far messier than two curves.
- Counting all cash received as income. Under the Hicksian view you also consider changes in wealth. Ignoring them can hide real gains or losses.
- Confusing Hicks with Keynes. Hicks translated and extended Keynes's ideas into a model, but they were different economists.
Questions
People also ask.
What is the IS-LM model?
It is a diagram that shows the combinations of interest rates and output at which the goods market and money market are in balance. It was drawn to explain Keynes's ideas.
What is Hicksian income?
It is the most you can consume in a period while leaving yourself as well off as at the start.
Did John Hicks win a Nobel Prize?
Yes, he shared the 1972 Nobel Prize in Economics with Kenneth Arrow for work on economic equilibrium and welfare.
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