Why Spending and Saving Must Balance: The IS Curve Explained

Lower interest rates → investment increases (borrowing is cheaper) → total demand rises → higher output.

Higher interest rates → investment decreases → demand falls → lower output.

That’s why the IS curve slopes downward: there's an inverse relationship between interest rate and output.

Total demand = Consumption + Investment + Government Spending + Net Exports (C + I + G + NX)

The IS curve focuses especially on interest-sensitive components like investment and sometimes consumption.

The idea: output adjusts to match demand — that’s equilibrium.

Increase in government spending → demand rises → IS curve shifts right

Increase in taxes or drop in consumer confidence → demand falls → IS curve shifts left

Shifts reflect changes in fiscal policy or other non-interest-rate demand factors.

The IS curve shows how fiscal tools like taxes or government spending interact with interest rates.

It’s the first step in seeing how policy choices influence national output.

In the full IS-LM model, the IS curve interacts with the LM curve to determine both interest rates and GDP.

The IS curve helps us understand how the real economy responds to interest rates and fiscal policy.

It sets the stage for analyzing policy effects, recessions, and recovery — by showing the balance between spending and output.