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Current time:0:00Total duration:6:07

Video transcript

in the last video we began to explore the is curve which as I think I mentioned stands for investment savings and we really analyzed it from the point of view of investment we were we thought of it as real interest rates driving the level of investment which drives the equilibrium level of real output high real interest rates low level of investment low level of investment leads to low equilibrium output so this scenario is closer to that right over there if real interest rates are lower then that leads to higher levels of planned investment which leads to a higher level of equilibrium output so that right over there what I want to do in this video so that was from more from the investment point of view what I want to do in this video is explore the exact same relationship the exact same curve but think of it more from the savings point of view and in this situation we're going to have this exact same thing but we're instead of viewing real interest rates as driving GDP we're going to view GDP as driving real interest rates and so let me leave this up here but let's just let's just break down the expenditure model of GDP so we know that aggregate income or aggregate GDP or aggregate output however you want to think of it is equal to into it you could break it up into its component expenditures it's equal to aggregate consumer spending which is a function of disposable income y minus T is disposable income aggregate income minus taxes plus investment plus investment plus government expenditures plus government expenditures and I could do net exports but for simplicity for this discussion we'll just assume we are in a closed economy it makes conceptualizing saving and investment a little bit easier now what I want to do is solve for investment so if I solve for investment I'm just going to subtract this piece and this piece from both sides of this equation and I get aggregate income minus total aggregate consumer spending total aggregate consumer spending - total government spending is equal to on the right hand side I'm just going to be left with I'm just going to be left with investment right over here and this thing right over here is interesting because this is total income - - well let me make sure that we I don't like confuse you because it looks like a lowercase e and if we're talking bout aggregate consumption it's usually an uppercase e so on the left hand side we have total aggregate income - consumer spending - government spending so you could really view this as this right over here really is aggregate savings this over here really is savings and as we see when on one side of the economy when people are saving that goes into banks and it gets a lent out and that get or or and then it gets reinvested or you could save directly by reinvesting and so what we have here savings is equal to investment and that's why it's called an is curve because when you look at the expenditure model savings and investment are really the same thing they could have they're really just saying look there's two ways to view this curve it's it's it's investment driven or its savings driven and when you think of it this way you have a slightly different view of this curve because when you view it from a savings point of view you say well what's going to happen if GDP goes up what happens if we have a high if we have a high GDP over here so if we have a high GDP or let's say let's say in particular for GDP if GDP goes up the consumer spending which is a function of GDP it will go up but it won't go up as much it's going to go up by this this expression right here times if we assume a linear model times the marginal propensity to consume which is less than one it's between zero and one so this is going to go up less than that and then we can work for the sake of this model we'll assume right now that that happens without any change in government expenditure so if this if total aggregate GD if total aggregate income goes up then savings are going to go up if we assume government expenditures holds constant so then we have savings savings goes up and if savings goes up that means we have more loanable funds there's more money to lend and if there's more money to lend what's going to happen to interest rates well interest rates are just the price of borrowing money the price of money so if you have more of something the price of that thing goes down so if savings goes then real interest rates real interest rates go down so if you have a high GDP you're going to end up with low real interest rates so once again it's looking at it from a point of view of GDP driving interest rates we have high savings here so we're going to have low interest rates and you view it the other way around if you have a lower if you have a lower income this thing is going to also decrease but it's not going to decrease as much as this did because of the the marginal propensity to consume is less than one we saw that up here we saw that all the way over here right over there and so an aggregate the savings are going to go down once again we hold government spending constant so in this situation savings savings are going to go down and if you have fewer loanable funds there's less savings to lend out then if you have a less of a supply of something what's going to happen to its prices price is going to go up the price of borrowing money is the interest rate so in this situation interest rates would go up so that's going in this direction right over here if aggregate income goes down loanable funds go down interest rates are going to be higher so once again same exact curve is curve but there's two takeaways here one is to realize why it's called is that investment in savings when you view it from this point of view really are the same thing one person's savings can be another person's investment and when we viewed it from the investment point of view we were viewing our as driving why now we're looking at the other way around why is driving savings which is driving our but it gives us the exact same relationship for this model