The major economic activities of the government that affect the aggregate demand for final goods and services can be summarized by the fiscal variables Tax (T) and Government Expenditure (G), both autonomous to our analysis. The government, through its expenditure G on final goods and services, adds to the aggregate demand like other firms and households. On the other hand, taxes imposed by the government take a part of the income away from the household, whose disposable income, therefore, becomes Yd = Y – T. Households spend only a fraction of this disposable income for consumption purpose. Hence, equation has to be modified in the following way to incorporate the government

Y = C̄ + Ī + G + c (Y – T)

Where, Y- Income, C-Consumption, G- Government Expenditure, I-Investment, c- Marginal Propensity to consume (MPC), T- tax.