Investment sales and the interest rate e In our first model of output determination, investment was left unexplained--we assumed it was constant even when output changed Investment is in fact far from constant, and it depends primarily on two factors ● The level of sales ● The interest rate To capture these two effects we write the investment relation as follows =(XY,) 5.1 Equation(5. 1)states that investment depends on production, Y, and the interest rate, i
Investment, Sales, and the interest rate In our first model of output determination, investment was left unexplained—we assumed it was constant, even when output changed. Investment is in fact far from constant, and it depends primarily on two factors: ●The level of sales ●The interest rate To capture these two effects, we write the investment relation as follows: I=I(Y,i) (5.1) (+,-) Equation (5.1) states that investment depends on production, Y, and the interest rate,i
The s curve Taking into account the investment relation (5.1), the equilibrium condition in the goods market becomes Y=C(Y-D+l(Yi+G 5.2) The supply of goods(the left side)must be equal to the demand for goods(the right side) Equation (5.2)is our expanded is relation We can now look at what happens to output when the interest rate changes
The IS Curve Taking into account the investment relation (5.1), the equilibrium condition in the goods market becomes Y=c(Y-T)+I(Y,i)+G (5.2) The supply of goods (the left side) must be equal to the demand for goods (the right side) Equation (5.2) is our expanded IS relation. We can now look at what happens to output when the interest rate changes
Demand.z 45 Line ZZ (for interest 1 ZZ (for interest i'>i) OutputY Interest rate1 IS curve Y Output
Demand,Z 450Line ZZ A (for interest i) ZZ' (a) (for interest i'>i) A' Y' Y Output,Y interest rate i (b) i' A' i A IS curve Y' Y Output,Y
Shifts in thes curve Interest. 1 IS(for taxes T) s(for T'>T) OutputY
Shifts in the IS Curve Interest,i i IS(for taxes T) IS'(for T'>T) Y' Y Output,Y
Summarize e Equilibrium in the goods market implies that output is a decreasing function of the interest rate e This relation is represented by the downward- sloping is curve e Changed in factors that decrease or increase the demand for goods given the interest rate shift the is curve to the left or to the right
Summarize Equilibrium in the goods market implies that output is a decreasing function of the interest rate. This relation is represented by the downwardsloping IS curve. Changed in factors that decrease or increase the demand for goods given the interest rate shift the IS curve to the left or to the right