Shifts in Is/position of Is Curve (With Diagram)

Shifts in Is/position of Is Curve:

Shift in IS curve is due to (a) change in Autonomous spending (A) with interest rate constant or (b) change in taxes

Assume: Initial AD → AD₁

Autonomous spending → A

interest rate → i₁

goods market is in equilibrium at point E₁ because Y = AD at point E₁

Equilibrium output level → Y₁

Thus, point E₁ corresponds to a point on the IS curve (IS₀)

If Autonomous spending increases to A₁ for e.g.

due to increase in I at a given interest rate → i₁, firms plans to invest more,

or due to increase in government expenditure the IS curve will shift to the right from IS₀ to IS₁.

As investment is a component of AD, increase in investment at a given interest rate i₁ will lead to shift in AD curve.

.^.. AD curve shifts parallel upwards to AD₂

Y = AD at point E₂ at same interest rate → i₁

.^.. Income level increases to Y₂

Point E₂ corresponds to a point on the new IS curve (IS₁)

IS shifts horizontally by distance = α_G.∆A or α_I ∆ A

Thus, due to increase in A, the IS curve shifts to the right.

However, the change in income due to ∆A will depend on the value of multiplier.

Slope of Is Curve:

IS curve is negatively sloped because an increase in the interest rate decreases the investment, which in turn decreases AD and thus decreases the income level.

I. Value of b:

(a) If b is large (high) → IS curve will be almost flat because the Investment spending be very sensitive to i(∆I > ∆i)

A small change in interest rate will lead to a very large change in investment. Therefore, AD curve will shift by a large amount. A large shift in AD will produce a large change in the equilibrium income level. Since a small change in interest rate produces a large change in the IS curve, the IS curve is almost flat. (∆I < ∆i)

(b) If b is small → IS curve will be relatively steep (almost vertical) because investment spending is not very sensitive to interest rate. (∆I < ∆i)

II. Role of Multiplier:

Equation (via) shows that if b and α_G are small then a change in income associated with a change in interest rate will be large, that is, ∆Y will be less. That is, lesser the value of α_G and b, greater will be the slope and steeper will be the IS curve.

This implies that when interest rate changes, although the intercept of AD will change by same amount but, the change in income will be different. This is because the change in income due to change in interest rate will depend on α_G.

(a) Difference between AD₁ and AD₃ is due to the interest rate:

When interest rate decreases from i₁, to i₂, Fig. (9.2). Investment will increase. As investment is a component of AD, the intercept of AD will increase by the same amount (-b∆i).

Thus, AD curve shifts parallel upwards to AD₃.

Income level increases from Y₀ to Y₂.

(i) It shows movement along the IS curve: (IS₁), because interest rate has changed, that is, decreased from i₁ to i₂.

(b) Similarly, parallel shift in AD curve from AD₂ to AD₄.

Shows movement along the IS curve: IS₂, because interest rate has decreased from i₁ to i₂. (Fig. 9.2)

(ii) Difference between

(i) AD₁ and AD₂ and (ii) AD₃ and AD₄

is because of α_G, but the increase in income is different.