Macroeconomic equilibrium in the commodity market. Macroeconomic Equilibrium in the Commodity and Money Markets: TS-LM Model
As a result of studying this chapter, the student must:
know
- Components aggregate demand and planned costs;
- the mechanism for achieving an equilibrium volume of production in the Keynesian model "income - expenses";
- concepts of inflationary and recessional gaps;
be able to
- determine the factors affecting the macroeconomic equilibrium in the “income-expenditure” model;
- calculate indicators of the average and marginal propensity to consume and to save, cost multiplier, accelerator;
own
- skills of graphic representation of the model "income - expenses";
- the ability to determine the factors that ensure macroeconomic equilibrium in the “income-expenses” model;
- the skills of analyzing public policy measures based on the "income - expenditure" model.
Equilibrium of the commodity market in the "income - expenses" model
Another model that reflects the relationship between aggregate demand and aggregate supply is the Keynesian model of income-expenditure, which is also called the Keynesian cross. It is built on the assumption of fixed prices, which differs from the AD - AS model.
Let's note the main provisions Keynesian theory, which for several decades of the XX century. was at the heart of macroeconomic policy leading states of the world:
- aggregate supply does not determine demand, but aggregate demand determines the level of economic activity, i.e. aggregate supply and level of employment;
- wage and prices are not completely flexible;
- the interest rate does not equalize the volume of savings and investments;
- full employment is not achieved automatically, government intervention in economic processes is required.
In the Keynesian model, aggregate demand depends on consumption and saving functions. Unlike the classic economic theory, according to which the main factor determining the dynamics of savings and investments is the interest rate, according to Keynes, both consumption and savings are income functions.
The factors that determine the dynamics of consumption and savings include:
- household income;
- wealth accumulated by households;
- price level;
- economic expectations;
- magnitude consumer debt;
- the level of taxation.
The values of consumption and savings, provided that the state does not take special actions to change them, are relatively stable. Current consumption is less than income by the amount of savings. Therefore, to maintain balance, it is necessary that savings were transformed into investments. It should be noted that investment activities business entities are highly volatile.
Let's list the factors that determine the dynamics of investments:
- expected net profit margin;
- real interest rate;
- the level of taxation;
- changes in production technology;
- cash fixed capital;
- economic expectations;
- dynamics of total income.
To achieve equilibrium at full employment, according to Keynesian theory, the state must stimulate aggregate demand. Therefore, this theory is often referred to as the aggregate demand theory. The lack of aggregate demand is due to two main reasons.
1. The operation of the basic psychological law, according to which, as income grows, people increase the share of income going to savings: "The psychology of society is such that with an increase in total real income, total consumption also increases, but not to the same extent as income grows" ... To describe this pattern, the indicators of the average and marginal propensity to consume and save are used.
Average propensity to consume APC = C / Y shows what proportion of income goes to consumption.
Average propensity to save APS = S / Y characterizes the share of income that is saved.
Marginal propensity to consume MRS = AC / AY shows the change in the amount of consumption depending on the change in income.
Marginal propensity to save MPS = AS / AY determines the change in the amount of savings depending on the change in income.
2. Low rate of return on capital due to the high level of interest (this reduces investment demand from firms).
In these conditions, the task of the state is to compensate for the drop in aggregate demand with the help of government spending.
In the Keynesian model "income-expenses", market equilibrium is achieved when the total (planned) costs AE(i.e. the amount that business entities plan to spend on the purchase of goods and services) are equal to total income N1(national income) - real expenditures that firms carry out, and N1 = DI(disposable income). N1 = DI denote Y. The expense stream represents the aggregate demand and the income stream represents the aggregate supply. To build a model, you need to write down the following equalities:
From G and Exn(demand from the state and the external market) at this stage of the study, we abstract.
Hence,
We build a coordinate system (Fig. 5.1). To determine the point of equilibrium, it is necessary to draw a line of iodine at an angle of 45 °. All points of this line are in equilibrium: expenses are equal to income (AE = Y). To find the balance point we need, it is necessary to build a consumption line.
In Keynesian theory, as mentioned in the previous chapter, the main factor determining the dynamics of consumption and savings is the size of the disposable income of households. The consumption function has the form
where With a- autonomous, i.e. consumption that does not depend on changes in income (for example, it will be equal to 100 units); MRS- the marginal propensity to consume (let's take it as 0.8); Y - disposable income (income after tax deductions).
Rice. 5.1.
Let's build a line WITH. Let's take Y as zero. Then WITH will equal With a(100). Let's give Y, for example, the value of 200 units. Then WITH= 100 + + 0.8 x200 = 260.
At the point of intersection of the line of consumption with the line at an angle of 45 °, all income is consumed. At consumption values above this point, part of the income goes to savings. If consumption exceeds disposable income (the area to the left of the tipping point), then it is carried out in part at the expense of previous savings.
Now you need to build a line of savings and find the point where investment equals savings. Building a savings line
where S a - autonomous saving, S a = -C a; MPS - marginal propensity to save.
When Y = 0, this line will pass through the point (-100), since all savings will go to consumption. Where the intersection of the 45 ° line and the consumption function is projected onto the axis OH, savings are zero (S = 0).
Now you need to find the point of intersection of the savings line with the investment line.
Investments are autonomous and induced (stimulated). Autonomous investments do not depend on the level of income, are determined by external circumstances (mineral reserves, external markets, etc.). Investments are called induced if their value increases with the growth of GDP, i.e. they are caused by a steady increase in demand for goods. Induced investments, superimposed on autonomous ones, enhance economic growth.
The investment function has the form
where e + 1 (f) - investments autonomous from total income; e - autonomous investments driven by external economic factors; / (r) - real interest rate; / (Y) - induced investment.
Investment demand is quite volatile, but in our example we will make the assumption that the investment demand is 50 units. at all income levels. By projecting the intersection point of the line S and lines I on a line at an angle of 45 °, we will find the balance point. Straight AE = WITH+ / will also pass through this point (parallel to line C).
Determination of the point of general equilibrium is necessary for forecasting the development of the economy. If at the moment the actual Y less than equilibrium, which means that firms produce less than buyers are willing to purchase (AD> AS), and the economy can be expected to expand. If the size of the national income exceeds the equilibrium level, i.e. buyers buy less goods than firms produce (A9 AD), inventories rise, and firms reduce production.
The equilibrium level of output fluctuates in accordance with changes in the components of total expenditures (C, I, G, Exn), moreover, an increase in expenses causes a multiple increase in income.
The question arises: how much will the national income change as a result of changes in spending?
Multiplier of autonomous costs is the ratio of changes in the equilibrium volume of national production to changes in any component of autonomous expenditures. It shows how many times the total increase (decrease) in total income exceeds the initial increase (decrease) in autonomous expenses:
where MULT- multiplier of autonomous expenses; A Y - changes in the equilibrium volume of national production; AL - the change in autonomous costs, independent of the dynamics of W.
Simple multiplier formula
Let's look at the multiplication process using a simple example.
Example. Let us assume that the growth of autonomous investments in society is 1000 units. On the one hand, these are costs. On the other hand, income. These funds materialize in the form of labor, equipment, raw materials and other goods. The owners of these factors of production will receive an income equal to 1000 units. At MRS = They will spend 0.75 on consumption 750 units, and on savings - 250 units. 750 units they will also become expenses for someone, and income for someone (Table 5.1).
Table 5.1
Animation process
As a result, the initial investment of 1000 units. led to an increase in national income to 4000 units. (with a multiplier equal to 1 / 0.25 = 4, 1000 4 = 4000).
Thus, the action of the multiplier, which multiplies the consequences of changes in autonomous expenditures, is a factor that enhances government stimulation of aggregate demand. However, it can enhance economic instability... Therefore, the government's task is to create a system of built-in stabilizers to dampen fluctuations in business activity.
As shown above, the equality between the aggregate demand and the aggregate supply requires the observance of the equality of the volumes of savings and investments: I = S. Since investment is a function of interest, and savings is a function of income, the problem of finding their equality is very difficult.
The imbalance between planned investments and savings can lead to two negative effects for the functioning of the economy:
- inflationary gap;
- deflationary gap.
An inflationary gap is a situation in the economy in which the planned expenditures (E on the vertical axis) exceed the potential level of total output, or the planned investments exceed the savings (/> 5) corresponding to a situation of full employment, i.e. the supply of savings by the household sector lags behind the investment needs of firms (Figure 5.2).
Rice. 5.2.
In this situation, the population will direct most of the income to consumption, the demand in the markets for goods and services will increase, which will increase the rate of price growth, i.e. will cause inflation. Thus, the economy will be able to independently come to a state of equilibrium corresponding to the point Y 0, and the inflation gap will increase due to the multiplier effect.
To overcome the inflationary gap, it is necessary to restrain aggregate demand and move the equilibrium to the point E (. The decrease in the equilibrium total income should be
A recessionary (deflationary) gap is a situation in the economy in which the planned expenditures are less than the potential level of total output or the planned investments are less than the savings (/ S) corresponding to the situation of full employment, i.e. the supply of savings by the household sector outstrips the investment demand of firms.
In the context of a recessionary gap, the population will save most of the income, the demand in the markets for goods and services will decrease, which will cause overproduction and lower prices, as well as a subsequent decline in production and layoffs of workers. The decline in employment and the decline in income in the economy will continue until the effect of the multiplier ends. Thus, the recession gap will gradually narrow, the economy will independently come to a state of equilibrium corresponding to the point E b however, this will be accompanied by a decline in production and unemployment.
To overcome the consequences of the recessionary gap and ensure full employment of resources, it is necessary to stimulate aggregate demand (aggregate spending) to the point that the equilibrium moves to the point E 2. The increment in equilibrium income will be equal to
To close or narrow the recession gap, Keynes proposed:
- realize public policy redistribution of income to increase consumer demand;
- reduce the real interest rate to increase investment demand;
- increase government spending.
To close or narrow the inflationary gap by reducing the components of the planned total expenditure (aggregate demand), Keynes proposed increasing taxes and cutting government spending.
It should be noted that the principle of animation has a two-sided effect. The increase in savings by the population in conditions of underemployment and insufficient demand gives rise to the "paradox of thrift" - it reduces savings and investments in society as a whole. Even a small reduction in investment has the opposite multiplier effect - a multiple decrease in national income is that an increase in savings at the macrolevel (an increase MPS) may hinder economic growth... Indeed, the Keynesian cross shows that an increase in savings and, accordingly, a decrease in consumer spending, decreases the equilibrium level of GDP. The mechanism of this phenomenon is simple: a reduction in consumption will cause an overstocking of warehouses with unsold goods, a reduction in the income of entrepreneurs will lead to a curtailment of investments and a reduction in production.
However, the growth of savings can also play a positive role in the economy, but only if the money market quickly and completely turns them into investments, then there will be no overall reduction in total expenditures, and the structure of the economy will change towards an increase in the rate of accumulation, which can lead to accelerated economic growth.
- Keynes J .. M. General theory employment, interest and money. An anthology of economic classics. M .: 1993.Vol. 2.P. 155.
Theoretical task:
1) Describe the equilibrium models of the commodity market;
2) How do the differences between the classical and Keynesian models in the understanding of investment and savings influence the results of economic analysis?
3) What are the assumptions that significantly limit in reality the implementation of the conclusions obtained in the framework of Keynesian theory?
4) How do the life cycle and permanent income hypotheses resolve the contradictions that have arisen regarding the consumption function of J.M. Keynes?
1. Briefly describe the equilibrium models of the commodity market.
Macroeconomic or general economic equilibrium- this is such a state national economy when there is an equilibrium between aggregate demand and aggregate supply.
The equilibrium of the commodity market is ensured by the ratio of the aggregate demand for goods and services (AD) and the aggregate supply of goods and services (AS).
There are two approaches to explaining the equilibrium of a commodity market: classical and Keynesian.
Classic approach
The economy is divided into two sectors: real and monetary, which in macroeconomics is scientifically called the "classical dichotomy" the money market does not affect real indicators, which is called the principle of money neutrality. This principle means that money does not affect the situation in the real sector and all prices are relative.
There is perfect competition in all real markets.
Since there is perfect competition in all markets, all prices are flexible, i.e. prices change, adapting to changes in the ratio of aggregate demand and aggregate supply, and ensure the restoration of the disturbed equilibrium in any of the markets and, moreover, at the level of full employment of resources
Since prices are flexible, equilibrium in the markets is established automatically
Since equilibrium is ensured by an automatic market mechanism, no external force should interfere with the functioning and regulation of the economy. This is how the classics justified state non-interference in the economy.
The main problem of the economy is the limited resources, therefore all resources are used in full and the economy is always in a state of full employment of resources, i.e. the most efficient use of them, therefore the volume of output is always at the level of potential
The scarcity of resources makes the problem of production the main one in the economy, i.e. the problem of aggregate supply, therefore the classical model is a model that studies the economy from the side of aggregate supply
The problem of limited resources is being solved slowly, so the classic model is the model describing the short term
Keynesian approach
In the mid-30s of the XX century. a new employment model was formulated. Its founder was John Maynard Keynes, who in 1936 published the book "General Theory of Employment, Interest and Money", which outlined the fundamental concepts of new employment. J. Keynes completely rejected the classical theory of employment, arguing that the capitalist market economy does not have any mechanism for regulating employment at all, and that with a certain regulatory role of the state, it is possible to achieve a balanced economy both with a significant level of unemployment and with significant inflation. It turned out that full employment of the population is an absolute accident, and not a pattern, and capitalism cannot be any self-regulatory system capable of endless prosperity, it is a system that requires constant control and regulation by the state. Unemployment and inflation were considered by J. Keynes as natural properties of capitalism, which the state can smooth out by regulating the population's savings and entrepreneurial investments. He argued that under capitalism, as a rule, a decrease in prices is accompanied by a decrease in wages, which means that the profitability of consumers decreases and there is no elasticity between pricing, primarily for food products and services, and cannot be.
The Keynesian employment model rejected Say's law in the sense that savings of the population through interest bank rates are given in accordance with the investment activities of entrepreneurs. No, Keynes said, it is not at all necessary for entrepreneurs to increase investment if the population accumulates savings. In turn, the fall in commodity prices not only does not stimulate investment, but, on the contrary, inhibits entrepreneurial activity. Therefore, the subjects of savings and investors are not synchronous groups of the population, but completely independent, independent from each other, market actors, developing plans for their savings and investments on different grounds. Keynes argued that the savings rate is weakly correlated with the rate of bank interest Moreover, it is possible to give reasons and examples when savings are inversely related to the level of interest rates. So, savings can be made in order to make a large purchase over time (for example, a car), sometimes savings are made for the sake of convenience (buy when you want or become possible), savings can be made just like that, for no reason.
In turn, the interest rate does not have a strong synchronous relationship with investment. Here, the more effective factor is usually the rate of profit, and in the event of a decrease in product prices, it usually decreases.
Macroeconomic equilibrium on the product market (model IS)
Model IS (investment - savings) is a theoretical equilibrium model for only commodity markets with fixed prices. It reflects the relationship between the interest rate ( r) and the size of the national income ( Y), which is determined by Keynesian equality.
In the analysis presented by J.M. Keynes and Stockholm economics school aggregate demand is equal to the demand for consumer and investment goods:
And the total supply is equal to the national income ( Y), which is used for consumption and savings:
The equilibrium in the commodity markets for the entire economy will look like: or, hence:
That is, savings and investments depend, respectively, on the level of income and interest rates.
The obtained Keynesian equilibrium condition allows for a plurality of equilibrium states of commodity markets, since the conditions of the interest rate and income in the economy can constantly change.
To determine this set of equilibrium states of commodity markets, the English economist John Hicks used the "investment - savings" model ( IS). This model allows you to find in each specific case the ratio between the interest rate ( r) and national income ( Y), in which investments are equal to savings with the constancy of other factors.
Model IS is considered in the short term, when the economy is outside the state of full employment of resources, the price level is fixed, the total income ( Y) and interest rates ( r) are mobile.
Investment-saving model - IS is of great practical importance, since it can be used to show how much it is necessary to change the interest rate when the national income changes in order to maintain equilibrium in the commodity markets. For example, if the interest rate is reduced, then investment will increase, which will lead to an increase in planned expenditures and an increase in national income. In turn, an increase in national income will cause an increase in savings in society and vice versa.
Rice. 3
macroeconomic equilibrium commodity market
If we depict these processes graphically, we get a decreasing curve IS(fig. 3).
Curve IS is the locus of points that characterize all combinations Y and r which simultaneously satisfy the identity of income with the functions of consumption, saving and investment.
Curve IS splits the economic space into two areas: at all points above the curve IS the supply of goods exceeds the demand for them, that is, the volume of national income is greater than the planned expenditures (stocks are accumulating in society). At all points below the curve IS there is a shortage in the commodity market (society lives in debt, stocks are decreasing).
Investments are inversely related to the rate of interest. For example, if the rate of interest is low, investment will grow. Accordingly, income will increase Y and savings will grow somewhat S, and the rate of interest will decrease in order to stimulate the transformation S v I... Hence, the slope of the curve shown in (Fig. 3) IS.
This is due to the fact that in the first case, for more high rate percent and a certain level of income, people prefer not to consume, but to put money in the bank, i.e. save, which reduces investment and aggregate demand. In the second case, at a low interest rate, society lives in debt and prefers consumption, thereby increasing investment in the economy and its total costs.
If you change factors that were previously considered constant, for example, government spending ( G) or taxes ( T), then the curve IS will shift to the right up or to the left down, depending on the change in the named indicators.
For example, if government spending rises and taxes remain unchanged under a stimulating fiscal policy, then the curve IS move up to the right. If taxes increase, and government spending remains at the same level with a restrictive fiscal policy, then the curve IS will move to the left and down.
Thus, the model IS can be used and is used in business practice to illustrate the impact on national income of the fiscal (fiscal) policy of the state.
Curve IS- equilibrium curve in the commodity market. It represents the locus of points that characterize all combinations Y and R which simultaneously satisfy the identity of income, the functions of consumption, investment, and net exports. At all points of the curve IS equality of investment and savings is respected. Term IS reflects this equality ( Investment = Savings).
Simplest graphical plotting of a curve IS associated with the use of the functions of savings and investment (see Fig. 2).
The analysis of equilibrium in the national market is carried out by combining the graphs of aggregate demand and aggregate supply in the same coordinate axes. The market system will be instate of equilibriumif, at the current price level in the economy, the value of the estimated volume of production in the economy is equal to the value of aggregate demand.
The intersection of the curves of aggregate demand and aggregate supply will thus determineequilibrium real volume of domestic production and equilibrium price level in the economy... Availability of aggregate supply on the chartthree specific sites complicates the analysis a little. Consider the situation of establishing macroeconomic equilibrium at each specific section of the AS chart.
The first case is the intersection of the graphs of aggregate demand and aggregate supply in the intermediate section of the latter... This case is the usual case when a change in the level of prices in the economy actually excludes overproduction and underproduction.
Macroeconomic equilibrium will be reached at point E with the following parameters: PE - equilibrium price level in the economy; QE is the equilibrium volume of production in the economy.
If the price level is higher than the equilibrium level, then a surplus of production will appear on the national market. The presence of surplus (excess supply) will "push" prices down to the level corresponding to the PE in the figure above. The opposite situation takes place if the price level in the economy is less than the equilibrium one. In this case, the economy will face the problem of a deficit in the national market. The shortage of products will allow raising prices to the initial level, that is, to PE. The possibility of changing the price level in the economy practically reduces to zero the situation of overproduction and underproduction, this allows market system self-regulation and balance.
The next variant of equilibrium between aggregate demand and aggregate supply will be considered on the Keynesian section of the AS graph (figure below). A feature of this version of macroeconomic equilibrium is that the price level throughout the Keynesian segment is unchanged and equal to PE. This means that prices, in contrast to the case considered above, here cannot be a tool to influence the market situation. If we assume that the economy produces more output than is demanded by the market, for example QA (QA> QE), then the economy will face an increase in unsold inventories (by (QA - QB)), which will not be accompanied by fluctuations in the price level ...
In response to the growth of inventories, entrepreneurs will reduce production volumes, gradually bringing them to the level corresponding to point E. If the volume of production in this economy is less than equilibrium, for example, QB, there will be a reduction in normal inventories. For producers, this will signal the need to increase production volumes, and the process of expanding production volumes will continue until the situation returns to normal, i.e. will not return to point E. All of the above allows us to conclude that in the Keynesian segment AS, it is the state of commodity stocks and their dynamics that act as a kind of indicator of the situation in the national market. Note that in both the first and second cases, macroeconomic equilibrium is achieved under conditions of underemployment and the equilibrium GDP turns out to be less than the potential GDP.
And finally, the last case -equilibrium of aggregate supply and demand in the classic section of the AS graph... This option means that macroeconomic equilibrium is achieved under conditions of full employment of economic resources.
Real volume domestic product here corresponds to potential GDP, i.e., GDP in full employment (Qmax). Full employment in the economy excludes overproduction and underproduction.
The situation of stable market equilibrium at the level of the entire national economy is more likely exception than a rule, and is quite rare, since aggregate supply and aggregate demand are influenced by many factors.
And the market for goods is illustrated model IS-LM.
The IS line got its name on the basis of the fact that in an equilibrium state in the market of goods, investments (I) are equal to savings (S). In turn, in the money market (which is reflected by the line LM) in an equilibrium state, the demand for money (L) is equal to their supply (M).
Basic equations of the IS-LM model:
- Y = C + I + G + Xn- basic macroeconomic identity.
- C = a + b (Y-T) is the consumption function, where T = Ta + tY.
- I = e - di- investment function.
- Xn = g - m "Y - n" i- net export function.
- M / P = kY - hi is the money demand function.
Internal variables of the model: Y (income), C (consumption), I (investment), Xn (net exports), i (interest rate).
External variables of the model: G (government spending), MS (money supply), t (tax rate).
The empirical coefficients (a, b, e, d, g, m ", n, k, h) are positive and relatively stable.
The model is considered at a constant price level (P = const); output or income (Y), which means that the supply of goods is absolutely elastic, i.e. entrepreneurs are able to offer as many domestic goods as they are requested; consumption (C) depends on income; investment (I) is a simple function of interest rate (i); nominal wages are considered constant, and since prices (P) are unchanged, real wages are also constant; there is a sufficient amount of unoccupied resources (including human resources). Therefore, changes in income in the IS-LM model lead to significant fluctuations in the level of resource use; export, import and government sector economies are excluded from the scope of analysis.
Joint equilibrium model IS-LM (or Hicks model) - concretization of the AD-AS model... It allows you to find such combinations nominal rate interest (R) and income (Y), at which equilibrium is simultaneously achieved both in the market for goods and in the market for money.
The IS line characterizes the market for goods. Here, changes in the interest rate (i) affect the investment. But, on the other hand, the interest rate plays an important role in the money market, which, in turn, is represented by the LM line. The IS-LM model will allow studying the fundamental differences between monetary (monetary) and fiscal (tax-credit) policies, as well as their compatibility with various states of the economic environment.
IS line offset. The type and slope of IS is determined by the position of the investment function and the savings function, i.e. depends on the value of the marginal propensity to invest at the interest rate (ΔI / Δi), as well as on the marginal propensity to save (MPS = Sy).
The shift in the IS line is a consequence of changes in parameters that are not associated with changes in either the interest rate or the propensity to consume or save.
The deteriorating economic situation in the capital market will lead to the fact that the expectations of investors' profit at a given interest rate will reduce real investment, i.e. move the investment line to the left. The concrete result of this will be a shift of the IS line, also to the left. In this case, the fall in investments occurred at a single interest rate due to the deterioration of investment expectations. That is, the shift of the IS line can be caused by the following main reasons: a shift in the saving function (S), or a shift in the investment function (I), or their simultaneous shift.
The IS line is not capable of showing the complete picture of an equilibrium economy. The interest rate (K) depends on the level of income (Y), and also determines the transactional demand for money. In turn, the transactional demand for money depends on the amount of income. The combination of transactional and speculative demand for money, as well as the supply of money, determine the equilibrium interest rate. The interest rate has an effect on savings and investments, and, accordingly, on the level of income. So a simple economic model can be represented as an interconnected system of joint equilibrium, in which the interaction of the market and money creates a single level of interest rate and income.
The LM line reflects all possible combinations of interest rate (i) and income (Y), in which the total demand for money is equal to the total supply of money (M). Thus, these combinations correspond to the equilibrium in the money market.
LM line offsets. A shift in the LM line can be caused by the influence of various factors: any change in the transaction demand for money, an increase in the amount of money. The configuration of the LM line changes with each change in the slope and elasticity of speculative demand (Ls). That is, the shape of the LM line is a reflection of the speculative demand for money (Ls) curve.
Joint balance- this is an equilibrium in the market for goods and the market for money, i.e. it is an equilibrium in two markets. General equilibrium is an equilibrium in all four macroeconomic markets (goods, money, securities, labor).
Combining the IS and LM lines into one system gives a graphic representation of the IS-LM model. Simultaneous equilibrium in the market for goods and in the market for money can exist only at the intersection of the curves IS and LM. It is nothing more than an equilibrium combination of income and interest rates in the market for goods and in the market for money.
The point of intersection of the curves IS and LM is the point of general economic equilibrium, in which, firstly, there is no deficit and surplus Money in circulation and, secondly, all free money is tied up and actively invested.
In turn, at points above or below the equilibrium point on the IS and LM curves, we can only talk about the state of partial economic equilibrium, achieved either in the commodity markets (on the IS curve) or in the money (financial) market (on the curve LM).
The IS-LM model allows you to determine the relative effectiveness of fiscal and monetary policies.
Fiscal expansion... Growth in government spending and tax cuts lead to crowding-out effects that significantly reduce the effectiveness of stimulating fiscal policy. If government spending G increases, then total spending and income increase, which leads to an increase in consumer spending C. An increase in consumption, in turn, increases total spending and income Y, and with a multiplier effect. An increase in Y contributes to an increase in the demand for money MD, since more transactions are made in the economy. An increase in the demand for money with their fixed supply causes an increase in the interest rate i. Enhancement interest rates reduces the level of investment I and net exports Xn. The fall in net exports is also associated with an increase in total income Y, which is accompanied by an increase in imports. As a result, the growth in employment and output caused by the stimulating fiscal policy is partially eliminated due to the crowding out of private investment and net exports.
Monetary expansion ... An increase in the money supply allows for short-term economic growth without crowding out, but has a contradictory effect on the dynamics of net exports.
Increase money supply Ms is accompanied by a decrease in interest rates I, as the resources for lending expand and the price of the loan decreases.
This contributes to the growth of investment I. As a result, total expenses and income Y increase, causing an increase in consumption C. The dynamics of net exports Xn is influenced by two opposing factors: the growth of total income Y, which is accompanied by a decrease in net exports, and a decrease in the interest rate, which is accompanied by it. growth. The specific change in the value of Xn depends on the magnitude of changes in Y and i, as well as on the values of the marginal propensity to import.
Both fiscal and monetary expansion has only a short-term effect of increasing employment and output, not contributing to the growth of economic potential. The task of ensuring long-term economic growth cannot be solved with the help of a policy of regulating aggregate demand. Incentives for economic growth are linked to aggregate supply policies.
Basic concepts of the topic
Investment-savings (IS) curve. Liquidity preference over money (LM) curve. Model IS-LM. Joint balance. General equilibrium. Fiscal expansion. Monetary expansion. Crowding-out effect.
Control questions
- What are the internal variables that drive the IS-LM model?
- What external variables determine the IS-LM model?
- What are the fixed factors that drive the underemployment economy in the short run?
- What variables determine the economy of underemployment in the short run?
- How to graphically derive the IS curve, having a savings function and an investment function?
- How to derive the IS curve using Keynes's cross?
- Under what conditions is the IS curve flatter?
- Under what conditions is the LM curve relatively flat?
- What is the essence of fiscal expansion?
- How does the essence of monetary expansion manifest itself?
- Under what conditions is the crowding out effect relatively insignificant? In what conditions is it significant?
- What needs to be done in order to fiscal policy has become effective?
- When is fiscal policy relatively ineffective?
- How can the stimulating effect of monetary policy be achieved?
- When is monetary policy least effective?
- Give the aggregate demand equation.
- What fiscal policy should be in response to price level changes?
- Which money-credit policy compensates for changes in price levels?
- What happens to the interest rate, income level, consumption and investment in accordance with the IS-LM model if:
a) central bank reduces the supply of money;
b) the state reduces purchases of goods and services;
c) the state cuts taxes;
d) the state reduces purchases and taxes by the same amount. - Explain why the results of any changes in fiscal policy depend on how the central bank will react to them.