Macroeconomics, 2nd Edition by Pearson

THE

IS–LM

MODEL

257

expenditures. We have already seen that bond financing initially increases real

income by



Y

=



G

and the increased real income induces a further rise in

consumption expenditure of

c

1



Y

making the horizontal shift of the

IS

curve

equal to



Y

=



G

+

c

1



Y

or,



Y

=



G /

(1

-

c

1

).

In contrast, if the increase in government expenditure is financed by raising tax

revenues,



G

=



T

, the initial increase in real income due to the increase in govern-

ment expenditure induces an increase in consumption expenditure given by

c

1



Y.

However, now there is an offsetting effect ...