Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

8.2.1 The Goods Market and the IS curve: 
 
The goods market equilibrium is given by the IS schedule, 
which shows the combinations of interest rates and level of 
output. The goods market is in equilibrium when the supply of 
output is equal to aggregate demand or when investment is equal 
to the savings.
In symbols, 
 
 
The set of equation for equilibrium income in the Keynesian Three 
Sector Model is given as below. 
_______________ (1) 
Where, Y = Income/output 
AD = Aggregate Demand 
In Three Sector Model, 
_______________ (2) 
Where, 
C  = Autonomous Consumption (It is that level of consumption 
when level of income is Zero) 
c = Marginal Propensity to Consume (MPC: It is the ratio of 
change in consumption to change in income) 
Yd = Disposable income, defined as
TR = Transfer income (e.g. unemployment allowances) TR is 
assumed to be constant. 
The terms IS and LM are shorthand representations, 
respectively, of the relationship investment (I) equals savings (S) - 
goods market equilibrium 
– and money demand (L) equals money 
supply (M), or money market equilibrium. The Classical article that 
introduced is J.R. Hicks, ―Mr. Keynes and the Classical: A 
Suggested Interpretation.‖ Econometrica, 1937, pp. 147-159 
Y
AD
I
S
Y
AD
AD
C I G
Y
C I G
C
C cYd
Yd
Y T TR
TR
TR
T
tY

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T = Amount of tax, defined as
T = Tax Rate 
In Keynesian Model, I or Investment and G government demand for 
goods is assumed to be constant. 
i.e. 
Here the 
Define
At equilibrium, 
_____________ (3) 
Where, c = MPC 
t = Tax Rate 
Now define, c =
In the above model, Investment Demand ‗I‘ have treated as 
constant factor. 
We now introduced interest rate as a variable in the model and 
define Investment Demand as a inverse function of Rate of Interest. 
_______________ (4) 
Where, 
I
= constant component of Investment Demand 
i = Rate of Interest 
-b = responsive of investment demand to change in interest 
rate, b > 0 
The negative sign indicate that when interest rate rises, 
investment demand falls and vice-versa. Hence equation nos. 3 is 
written as 
_________________ (5)