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Q. Explain the basic characteristics of IS-curve?
IS-LM diagram
IS-curve
The IS curve shows all combinations of R and Y where the goods marketis in equilibrium. The IS-curve slopes downwards.
The goods market is in equilibrium when YD(Y, R) = Y. Note that when R is given, IS-LM simplifies to cross model:
Figure
If we know R, we can figure out the equilibrium value of Y using the cross model. Additionally, if we know Y we can conclude R from the money market. None of the methods, though, will gives us both Y and R simultaneously.
Consider the following question: What should happen to Y when we change R if we want the goods market to remain in equilibrium? To answer this question, consider two different interest rates R1 = 5% and R2 = 10%. As YD relies negatively on R, YD(Y, R1) would be larger than YD(Y, R2). With a higher R, we should have a lower Y for the goods market to be in equilibrium.
Explain the adjustment to the new equilibrium price from an increase in demand.
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