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Here's a lecture about ISLM and effective demand.
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So Far
Outline of Macroeconomics
History & Development of the Subject
IS-LM
IS-LMDeveloped by Hicks (1937) and others
Simple, BOE calculating Model (or is it?)
Lots of Problems:
Long Run/Short Run
Aggregation Problems
Idea of ‘One’ Interest Rate
‘Dark Forces of Time & Ignorance’
Demo
Today
ISLM & Effective Demand (ED)
Message: Output of Economy Depends on Components of ED
Effective Demand
Assume there are N workers, and a static production technology.
Let’s describe the calculations of the Firm.
Value of Output - (Factor Cost + User Cost) = Profit of Firm
Firm wants to Max(Profit)
Now from Economy’s POV:
Aggregate income is Factor Cost + Profit
Aggregate Supply Function (ASF) is expectation of proceeds from employment of resources in this way.
ASF = f(N), where N = No. of Workers
Aggregate Demand Function (ASD) is expectation of proceeds from employing N workers.
ASD = f(N).
When ADF > ASF, employ more people
When ADF < ASF, fire people
@ ADF = ASF, entrepreneurs' expectation of profits will be maximised
Big Questions
Does Supply create Demand
Or, does Demand create Supply?
Dynamics
If N goes up, Ag. Income goes up, Consumption goes up.
Need increasing investment to absorb this
So eqm. level of employment depends on level of investment
What changes investment? Marginal Efficiency of Capital (MEC)
Summary
Income depends on employment of N workers
income/consumption relationship depends on propensity to consume, call this IC
income/investment relationship depends on MEC
Sum of IC and MEC is effective demand
Even better Summary
The volume of employment in equilibrium depends on
(i) the aggregate supply function, ASF
(ii) the propensity to consume, IC, and
(iii) the volume of investment
Let’s think about Ireland Right Now
Real GDP dropping at 4-6%
Deflation 2-4%
UE running at 11%, so far this year, expectations much higher
Domestic investment in toilet.
Where is effective demand?
Put ISLM and Effective Demand Together
Next TimeEmployment and Money
Read Article on Public Folders
Expect Sample Exam next Friday
