Use the Keynesian cross to derive the IS curve. which elements influence where an IS curve is located.
Derive the IS curve with the help of the Keynesian cross. Which factors affect the position of an IS curve.
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Use the Keynesian cross to derive the IS curve. which elements influence where an IS curve is located.
Deriving the IS Curve with the Keynesian Cross
The IS curve represents equilibrium in the goods market, where investment equals savings. It can be derived using the Keynesian cross, which illustrates the equilibrium level of income in an economy.
1. The Keynesian Cross
a. Aggregate Expenditure: The Keynesian cross model is based on the concept of aggregate expenditure, which is the total spending in an economy at different levels of income. It includes consumption, investment, government spending, and net exports.
b. Equilibrium Income: In the Keynesian cross, equilibrium income is determined at the point where aggregate expenditure equals aggregate output (or income). This is where the aggregate expenditure line intersects the 45-degree line, which represents points where expenditure equals income.
2. Consumption Function
a. Marginal Propensity to Consume (MPC): The consumption function is based on the MPC, which is the proportion of additional income that is spent on consumption.
b. Autonomous Spending: The consumption function also includes autonomous spending, which is the spending that occurs regardless of income.
3. Investment
a. Interest Rate Dependency: Investment is assumed to be inversely related to the interest rate. Higher interest rates make borrowing more expensive, reducing investment.
4. Deriving the IS Curve
a. Combining Factors: To derive the IS curve, we combine the consumption function and investment function, considering government spending and net exports as exogenous.
b. Interest Rate and Income: The IS curve plots the combinations of interest rates and income levels where the goods market is in equilibrium. As interest rates decrease, investment increases, leading to higher aggregate expenditure and higher equilibrium income.
Factors Affecting the Position of the IS Curve
Changes in Autonomous Spending: Increases in autonomous consumption, investment, government spending, or net exports shift the IS curve to the right. Decreases in these components shift it to the left.
Changes in Interest Rate Sensitivity: If investment becomes more sensitive to changes in interest rates, the IS curve becomes flatter. If it becomes less sensitive, the curve becomes steeper.
Taxation and Fiscal Policy: Changes in taxation that affect disposable income and consumption can shift the IS curve. Expansionary fiscal policy (increased government spending or decreased taxes) shifts the IS curve to the right.
Consumer and Business Confidence: Changes in confidence can affect consumption and investment, thereby shifting the IS curve.
In summary, the IS curve, derived from the Keynesian cross, represents equilibrium in the goods market and is influenced by factors like autonomous spending, interest rate sensitivity, fiscal policy, and overall economic confidence.