Interpret the slope of the IS curve. Why is IS curve normally negatively sloped?
The slope of the IS (Investment-Saving) curve reflects the sensitivity of investment and, consequently, national income to changes in the interest rate. A steeper IS curve implies that a large change in the interest rate leads to only a small change in equilibrium national income, suggesting investment is not very responsive to interest rate fluctuations. Conversely, a flatter IS curve indicates high sensitivity.
The IS curve is normally negatively sloped because there's an inverse relationship between the interest rate and investment. When the interest rate falls, the cost of borrowing for investment projects decreases, making more projects profitable. This increases investment, which in turn boosts aggregate demand through the multiplier effect, leading to a higher national income. Conversely, a rise in interest rates makes borrowing more expensive, reducing investment and thus lowering national income. This consistent inverse relationship is why we plot the IS curve as downward-sloping.
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