EC4006 Intermediate Macroeconomics Lecture
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  • 1. EC4006 Effective Demand and IS-LM Stephen Kinsella | stephen.kinsell@ul.ie | stephenkinsella.net
  • 2. So Far Outline of Macroeconomics History & Development of the Subject IS-LM
  • 3. IS-LM Developed 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’
  • 4. Demo
  • 5. Today ISLM & Effective Demand (ED) Message: Output of Economy Depends on Components of ED
  • 6. 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)
  • 7. 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).
  • 8. When ADF > ASF, employ more people When ADF < ASF, fire people @ ADF = ASF, entrepreneurs' expectation of profits will be maximised
  • 9. Big Questions Does Supply create Demand Or, does Demand create Supply?
  • 10. 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)
  • 11. 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
  • 12. 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
  • 13. 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?
  • 14. Put ISLM and Effective Demand Together
  • 15. Next Time Employment and Money Read Article on Public Folders Expect Sample Exam next Friday