Macroeconomics, 2nd Edition by Pearson

THE

IS–LM

MODEL

261

Then, demand and supply of goods do not depend on

conditions in the labour market. We explicitly assume

these conditions hold. Otherwise, the income on the

left-hand side of Eq. (8.5) depends on the labour market,

and we would explicitly have to include excess demand

for labour in what follows.

6.

We are, therefore, assuming the substitution effect dominates

the income effect; see the section on effects of interest rates

in Chapter 3.

7.

The lifetime budget constraint will then be

C

1

+

[

C

2

/(1

+

r

)]

=

(

Y

1

-

T

)

+

[(

Y

2

-

T

)/(1

+

r

)]

8.

For simplicity, taxes in this chapter are ...