Why does a fall in the real interest rate lead to higher income?

CFA Level I Economics
#1

Hi all,

I’ve been trying to understand the theory leading to the construction of the IS curve.

One of the assumptions is that a rise in the real interest rate leads to the S-I curve shifting to the right resulting in higher income.

The CFAI text book, p.231 states “for any value of the saving-investment differential (S-I), the higher level of investment induced by a lower real interest rate requires a higher level of income to induce higher savings.”

Can anyone help explain this please?

#2

Am I right in assuming lower interest rates mean people will save less and increase consumption, whilst businesses will increase investment as the cost of capital decreases.

Thus, the creation of goods / services in the economy will rise and therefore output will rise. As output = income, income rises?

#3

Yup.

#4

Thanks! :slight_smile:

#5

My pleasure.