Macroeconomics: Theory and Policy

17

The IS–LM Framework for a Three Sector Model

After studying this topic, you should be able to understand

• In a three sector model, two new variables are included: government expenditure and taxation, G and T.
• There is only one combination of income and the interest rate at which there exists simultaneous equilibrium in the goods and money market.
• An increase in government expenditure by ΔG shifts the IS curve to the right by an amount equal to 1/1 – b × ΔG.
• The impact of taxes is felt through a change in the consumption level.
• A change in the money supply disturbs the money–market equilibrium causing a shift in the LM curve.
• By how much does the national income change in response to the monetary and fiscal policies depends on the elasticities ...