Desired income it is downward sloping since

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desired income. It is downward sloping since investment is an inverse function of interest rate. At higher the interest rates, there is lower investment spending, hence the lower the aggregate income. From the above diagram, at E 1 , interest rate is r 1 and corresponding income is Y 1 . As interest falls to r 2 and then r 3, aggregate expenditure curve shifts to E 2 and then E 3 while income increases to Y 2 and then Y 3 . Shifts of the IS curve Above the IS curve, Y > E, savings will increase and the IS curve will shift outwards. Below the IS curve, E >Y, is savings decline and the IS curve shifts inwards. IS 3 2 1 r r r 3 2 1 Y Y Y 3 2 1 r r r ) ( ) ( ) ( 1 1 2 2 3 3 r E r E r E Y AE r 32 Y
On the IS curve, E = Y and hence the goods market is in equilibrium. The IS curve is defined as the locus of points corresponding to rates of interest and levels of income that produce equilibrium in the goods/product market. An outward (inward) shift of the IS curve will be caused by an increase (decrease) in any of the following: - autonomous investment - autonomous consumption - government expenditure - exports (Net) Dis-equilibrium Income This occurs when I is not equal to S. S > I implies that AD = C + I < Y and C + S > C + I. This leads to accumulation of inventory forcing firms to reduce production and induce a decline in income and employment until S = I. S < I implies that AD = C + I > Y and C + S < C + I. This means inventories will be sold and businesses will produce more leading to increase in supply of goods and income until S = I. Planned investment and planned savings don’t always equal each other. Changes in employment, production and income occur causing changes in savings and investment. The direction of these changes will be towards equality of Savings and Investments (S=I) If planned investment and planned savings differ, changes in production will force consumers to change their savings plans or firms to change their investment plans (or both will occur) until I = S. It is only at equilibrium that both planned and realized investments and savings will be equal. However, realized investment and realized savings are always equal. 33
The Multiplier concept 0 0 0 0 0 I I
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I Y = 1 1 which is the simple investment multiplier. 35
Example Suppose Y 0 = 100 ΔI = 25 MPC = = 0.8, Change in income (ΔY) will be given by: ΔY = 8 . 0 1 1 x 25 = 2 . 0 25 = 125 Investment multiplier will be given by: I Y = 1 1 = 2 . 0

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