Page 170 - DECO402_Macro Economics

Unit-18: IS - LM Analysis

Notes

Figure 18.1 Figure 18.2
Figure – 18.1 shows that on the change in autonomous investment there is a shift in investment
demand function. The rise in autonomous investment will convert the investment curve II into II on
1
2
making a shift in it and the reduction in autonomous investment will convert the investment curve
II into II on making a shift in it.
1 3
II. How investment affects Aggregate Expenditure and the level of GDP
when ‘r’ happens to change?

Because of change in investment spending, there happens the change till the diversified range in total
expenditure. According to Investment Multiplier Theory if the interest rate remains constant then the
change in I can become the cause of the change in Total Spending (AE) and GDP. But if interest rate
(r) doesn’t remain constant (As in IS-LM Model) then the process of investment multiplier would not
be as easier. It is shown in figure 18.3 how the interest rate ‘r’ impacts on I and so impacts on total
spending AE and the level of GDP.
The parts (A) and (B) of figure 3 show the relationship between equilibrium actual GDP and investment
spending with the change in interest rate. Initial equilibrium is on point E where the rising in
investment expenditure from I I to I I , the total expenditure in part A become AE on shifting from
1
1 1
AE in AE = Y (Part A) and S = I (Part B). According to it, new balanced GDP should be OY where
1
AE = Y and S = I I . But the rise in level of GDP increases the demand of money and so becomes a rise
1 1
1
in ‘r’ in the situation of rise in interest rate, investment expenditure becomes low and so investment
curve shifts from I I to I I towards backside. According to it, in part A, actual total expenditure on
1 1
2 2
rising becomes AE instead of AE . Actual GDP becomes OY instead of OY . The high interest rate
1
2
1
2
decreases the investment expenditure, which further decreases the total expenditure. If interest rate
falls then vice-versa will be there. Therefore, the change in interest rate, by the change in investment
expenditure, affects actual GDP.
Self Assessment
Fill in the blanks:
1. We also derive the ………………………. demand curve from IS-LM Curve.
2. Because of change in investment spending, there happens the ……………… till the diversified
range in total expenditure.

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