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Lesson 3: IS-LM

# Loanable funds interpretation of IS curve

Thinking about how real GDP can drive real interest rates. Created by Sal Khan.

## Want to join the conversation?

• At , when Sal labeled Investment as equal to savings I was confused. From a previous video, I was expecting Saving to be complementary with Consumption, his 1-C where C is MPC is called Marginal Propensity to Save. Are the two savings the same thing? If they are the same, does Consumption complement Investment?
• (MPS= 1- MPC)
lets say a person is earning 100 \$, his savings will be (MPS * 100) and which will be saved in banks and banks will invest that money and thus savings=investments.
As GDP grows, more people will have more money in hand, which they will put in banks. Due to larger money, banks will lower interest rates and hence the IS curve .
• What would be the effect of change in MPC to IS curve? would it change its slope?
• The change in MPC such that consumers are saving more than they are consuming will increase national saving which in turn will shift the IS curve to the left, this is because the long-term steady state curve will increase. Note this shift is long term.
• I try to relate the I = S concept to the banking system and I don't think all of the savings in the banks will be lent out to be invested since they need to keep some for their reserves, so doesn't it supposed to be S > I ?
• As I understand it, "savings" and "investments" are really just two labels for the money that is leftover after consumers spending and government spending. Not all of this money would actually either be invested growing the economy, or squirreled away. It's not so important what actuall append to this money, it is just a label in this model to denote what is leftover, rather than to summarize what happens to the leftovers
• Will the IS Curve only apply to a closed economy that is NX = 0 ?
(1 vote)
• No, the IS relation applies in an open economy, too.
• Does the Interest Rate - Investment - Aggregate Output relationship, to some certain extent, explains what I'd like to call the "Circle of Poverty" which is befalling some Third World Countries at the moment ? Low Income => Low Savings => High Interest Rate => Low Invetment => Low Aggregate Output (Low Income) ?
(1 vote)
• No, not at all. Third world countries are at an enormous technological advantage when it comes to growth. They can take advantage of all the centuries of hard work that we put in to invent electricity, radio, TV, cell phones, and immediately they leverage all of that immense investment. Money invested in third world countries can be multiplied extraordinarily by taking advantage of these technological advancements. This means that investment `I` is more effective there, driving more growth, increasing GDP in real terms, thus increasing incomes.

The problem in third world countries is that they have tyrannical anti-freedom governments. You can predict the path a country will take thanks to the research collected here: http://www.heritage.org/index/ranking
• Could the conclusions we drew from this video say that a larger market is beneficial to everyone because of the higher GDP the interest rates will naturally be lower.
• Naturally low interest rates are evidence of a healthy economy and prosperous times. Note however that interest rates are frequently manipulated by heavy-handed government agencies that have their own agenda. When that happens you can't really draw any conclusions.
(1 vote)
• Will the slope of the IS curve only be affected by the responsiveness of investment to interest rate, government multiplier and MPC ?
(1 vote)
• Depends on the model, in this model yes it will, however in other models where other variables depend on income then the slope will likely depend on those variables as well e.g. if investment depended on income
• Is it correct to say that the IS Curve contains all points of income and respective rate of interest that equilibrium is being attained in the goods market as the equilibrium condition savings = investment is satisfied ?
(1 vote)
• I would say output instead of income, but yes that looks good.