IS Curve

Product market equilibrium refers to the equilibrium level of GDP as determined by the equality of aggregate demand and supply. Given the condition of aggregate supply, it is the level of aggregate demand that determines GDP level. According to the analysis made in where AD curve is derived from the aggregate expenditure by plotting all such points, where at various price levels, aggregate expenditure is equal to GDP. Aggregate expenditure, is equal to C + I + G + (X – M). If we assume a closed economy without government when AE = C + I and thus equilibrium level of national income is also where GDP = C + I. We also analysed and alternative approach of GDP determination wherein the equilibrium level of GDP is determined where I = S. Since, investment is an injection into the expenditure while S is a leakage, we find that equilibrium level of GDP is established where the injection is equal to leakage from the aggregate expenditure, Keeping in mind both these methods of national income determination, viz., GDP = AE and GDP --> I = S that define equilibrium in the product market (market that determines output of goods and services) we can proceed to derive the IS curve.

Derivation of the IS curve

The IS curve is derived on the basis of

• link between rate of interest and investment expenditure
• Investment expenditure and real GDP levels, and 
• The rate of interest, investment-savings (IS) and the level of real GDP or real national income.
  

IS curve thus shows equilibrium level of GDP associated with each possible interest rate.