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Q. Show the example on IS-curve?
Figure
We can explain this argument with the above figure.
1. Start by identifying R1 and R2 in lower graph.
2. Draw aggregate demand for both interest rates - the one corresponding to lower interest rate will be higher than the other.
3. Identify the resulting GDP in upper diagram for both interest rates - the highest level of GDP corresponds to lower interest rate.
4. Extend these levels of GDP to lower graph. This will give you two points in lower graph.
5. Continue with other interest rates if you like. Result will be a curve in the lower graph that we call the IS-curve.
IS curve will identify all combinations of Y and R where YD(Y, R) = Y, which is, where goods market is in equilibrium. Economy should be on this curve if commodity market is to be in equilibrium. Though an analysis of the goods market alone won't help us identify at which point all markets are in equilibrium. Note that cross model is denoted by a single point on the IS-curve - the point corresponding to exogenously given interest rate. Which is why we can determine Y in cross model only from commodity market.
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