Shift of the IS Curve I

The Investment-Savings (IS) curve shows combinations of interest rates and output where the goods market is in equilibrium. But this curve isn’t fixed; it can shift with changes in fiscal policy, such as government spending or taxation.

When the government increases spending, for instance, by building roads, it directly pays contractors, who then hire workers and purchase materials. This raises household incomes, thereby increasing consumption. As a result, aggregate expenditure rises, and the IS curve shifts rightward.

Graphically, this means higher output at the same interest rate. A similar rightward shift occurs when the government cuts taxes. With more disposable income, households spend more, boosting demand and output.

On the other hand, if the government raises taxes or reduces spending, households have less income to spend. Consumption falls, businesses scale back production, and aggregate expenditure decreases. This causes the IS curve to shift leftward, representing lower output at each interest rate.

These shifts in the IS curve visually capture the economy’s response to expansionary or contractionary fiscal policies.