To draw the IS curve, we need to first understand the relationship between interest rate and investment. Investment is inversely related to interest rate. This inverse relationship can be expressed as:
I = Io – br
Where: Io = autonomous investment
b = elasticity of investment with respect to interest rate (b>0) It measures the responsiveness of investment to changes in interest rate.
Since the IS curve shows the combinations of interest rate and income that brings about equilibrium in the goods market (i.e. equality between demand and supply), what we will need to do in order to draw the IS curve is to change interest rate and observe the
effect on Y.
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