Macroeconomics: Theory and Policy

APPENDIX B

The IS–LM Framework for a Four Sector Model

INTRODUCTION

In Chapters 16 and 17, we have focused on a closed economy. We are now in a position to relax this assumption and focus on an open economy in which there are four sectors: households, firms, government and the foreign sector.

THE IS–LM MODEL FOR A FOUR SECTOR ECONOMY

In the construction of a four sector model, two new variables which pertain to the foreign sector are included, exports and imports. The analysis is based on certain assumptions, some of which are the same as in the earlier models:

1. The price level is constant.
2. At that constant price level, the firms are willing to supply whatever output is demanded.
3. The short-run aggregate supply curve is perfectly elastic till ...