LL Schedule

3 Key excerpts on "LL Schedule"

• 

  eBook - PDF

  The Economics Companion

  • Graham Mallard(Author)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  In other words, it shows all combinations of interest rate and level of output at which there’s no excess supply or excess demand for output in the economy: everything produced is purchased either through consumption expenditure, investment expenditure or government expenditure. It’s in the product market that the level of output is determined. Δ Y Δ LP Δ r Δ ( ) P M Figure 9.10 Analysing the LM curve 183 the size of the economy 3 3 Key term: the LM curve The LM curve maps out all combinations of interest rate and level of output at which the money market is in equilibrium: at which the real supply of money is precisely equal to the demand for money (liquidity preference). It’s in the money market that the interest rate is determined. Given these definitions, the point at which the IS and LM curves inter-sect is the single combination of interest rate and output level at which both the product and money markets are in equilibrium at the same time. As both markets are in equilibrium separately, there’s no pressure on either the interest rate or the level of output to change and so the whole economy is stable. This is what it means for the economy to be in equilibrium in this model. Consider again Figure 9.11a and suppose the initial equilibrium in the economy is at an interest rate r 1 and an output level Y 1 : the existing IS and LM curves are those subscripted with the number one. We can now use this model to analyse the effects of a number of changes, each of which involves us going through a number of steps. We analyse two such changes here. 1 A change in the real money supply . Consider the LM diagram again, and assume the government expands the nominal money supply (M), in effect by simply releasing more units of currency into the economy.

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  eBook - ePub

  Macroeconomic Theory: A Short Course

  A Short Course

  • Thomas R. Michl(Author)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  transactions motive. This part of the demand for money is called the transactions demand for money. If our income goes up, we will spend more on consumer goods and therefore we will need to have liquidity available in the form of cash or a checking account balance.

  The interest rate affects our demand for money because any wealth held in money form cannot earn interest. The interest rate is the opportunity cost or penalty for holding wealth in liquid form. Because the interest rate is the cost of liquidity, we will desire less money and more bonds in our optimal portfolio as the interest rate increases. This is the asset motive, or speculative motive for holding money, and this part of the demand for money is called the speculative demand. (We will explain why the peculiar term speculative is used later.)

  In general, the demand for money is written as a function Md = PL(Y, i) where PY represents nominal income. The symbol L derives from the fact that this function describes the demand for liquidity, and this approach to asset markets is called the theory of liquidity preference. The simplest linear form of the demand for money is

  M d

    =   P

  (

  d 1

  Y   −  

  d 2

  i

  )

  The price level appears outside the parenthesis in conformity with economic theory. If prices double (say), the demand for money should also double. The parameters d1 and d2 will be called the income sensitivity and the interest sensitivity of the demand for money. According to economic theory, their values depend on the underlying preferences of the households and on institutional details of business organizations and the financial system.

  The demand for money in real terms is also called the demand for real balances. By simply rearranging terms in the linear demand for money, it is written

  (5.1)

  M d

  P

    =  

  d 1

  Y   −  

  d 2

  i

  It turns out to be much easier to work with the demand for and supply of real balances.

  When economic agents choose a demand for money, they also choose the velocity of money. For example, under Equation (5.1), the velocity of money would be defined by V = PY/M = Y/(d1 Y − d2 i). In general, the velocity of money is a function of real income and interest rates, or V = V (Y, i

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  Finance Constraints and the Theory of Money

  Selected Papers

  • S. C. Tsiang, Meir Kohn(Authors)
  • 2014(Publication Date)
  • Academic Press

    (Publisher)

  Closely associated, though the exponents of that monetary economics deployed supply and demand analysis to elucidate the relationship between money and prices, the analysis to which that label was attached was very different from anything to which we would now apply it. In those pre-Marshallian days, the importance of conceiving of supply and demand as schedules, as opposed to simple quantities, was by no means fully appreciated, nor was the stock-flow distinction clearly understood. Even so, when we cut through their semantic imprecision, we find that when classical monetary economists spoke of the supply of money they usually meant the nominal value of a flow of money expenditures, while by demand for money they meant a flow of real goods and services offered in exchange for it. The price level was then determined by the interaction of these two flows because of the accounting necessity that the values of nominal outlays and receipts must be equal for the economy as a whole. By the 1960s, in contrast, the analysis of the supply and demand for money was cast firmly in terms of stocks. Moreover, such analysis was treated not as a piece of theory sufficient by itself to tackle any interesting problem but as a component of some more complex general equilibrium system, of which the Hicks-Hansen IS-LM model is the archetype. This, be it noted, is as true of work in the tradition of Friedman's New Quantity Theory as anything to which the Keynesian label could be attached.

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