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ISLM Model Example (with income taxation)
Given the following information, derive the equations for the IS and LM curves.
C = C
0
+ c Y
D
(A)
Consumption Function
I = I
0
+ I
Y
Y – I
r
r
(B)
Investment Function
G = G
0
(C)
Government Spending
T = T
0
+ t Y
(D)
Taxes (as a function of Income)
Y
D
= Y – T
(E)
Disposable Income
(M/P)
d
= L
0
+ L
Y
Y – L
r
r
(F)
Money Demand (Demand for Real Money Balances)
M/P = M
0
(G)
Money Supply
c = marginal propensity to consume [a coefficient]
C
0
= autonomous consumption [exogenous variable]
I
0
= autonomous investment [exogenous variable]
I
Y
= income sensitivity of investment spending [a coefficient]
I
r
= interest rate sensitivity of investment spending [a coefficient]
L
o
= transactions demand for money [exogenous variable]
L
Y
= income sensitivity of money demand [a coefficient]
L
r
= interest rate sensitivity of money demand [a coefficient]
You can use equations (A) through (E) to determine the equation for the IS curve.
Please note that this is the long way
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 Spring '09
 Smith
 Macroeconomics, ISLM Model

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