A Simple Overview of Keynesian_ Monetarist and New Classical and

					A Simple Overview of Keynesian, Monetarist and
New Classical and New Keynesian Approaches to
       Analysis of short run fluctuations

                  IS2                         LM3   LM2    LM1

            IS1



                                                    Models I, II, IIIA IIIB



 Interest
 rate, i




                        Macroeconomic Themes: 2                               1
Summary of Four Macro Models in the above Figure
     Government expenditure rises IS1 shifts to IS2. Impact on
     output according to four different macroeconomic models.

     Model I is simple Keynesian model for the real sector.
     Good market equilibrium is given by the downward sloping
     IS curve because lower interest rate stimulates the
     aggregate demand.

     Model II includes money market. It is given by upward
     sloping LM function which shows money market
     equilibrium with the rising level of demand for money as
     income rises. This includes interest rate feedback.

     Models I and II are Keynesian and new Keynesian models.

     Model IIIA includes a price feedback. When AD rises price
     also rises. It reduces real balances and there is less demand
     for output. This is the monetarist proposition in the short
     run.

     Model IIIB monetarist proposition in the long run and New
     Classical model with rational expectation.
                          Macroeconomic Themes: 2                    2
IS-LM and Aggregate Demand and Aggregate Supply
                    Analysis
                          IS2                        LM3   LM2        LM1

                    IS1



                                                               Models I, II, IIIA IIIB



       Interest
       rate, i




                                      Y0    y1 y2          y3

                                LAS
                                                         SAS




      Price level




                                Macroeconomic Themes: 2                                  3
                                       Y0   y1      y2
     Specification of the IS-LM
               Model


Consumption:            C  a  bY d       (1)
Disposable income:       Y d  Y T        (2)
Investment:              I r   I  q r (3)
                                   0
Demand for real balances: M  kY  r (4)
                             P
National income identity: Y  C  I  G    (5)


                  Macroeconomic Themes: 2        4
Equilibrium in Model I: Keynesian Multiplier
 Put equation (2) into (1), then use the resulting equation for C
 and the investment (3) into (5) and solve for Y (Model I).
                       a  bT  I  qr  G
                    Y           0         (6)
                              1 b
 This is goods market equilibrium or the IS curve according to
 Hicks (1933).
 It is a downward sloping line: Y  
                                       q  0 ; and
                                    r    1 b
    1 bY  a  bT  I  G
 r          
                    q
                             0
 In terms of saving investment identity: Y  C  G  I r  ; when
 income rises saving is greater than investment, the interest rate
 should fall to accommodate an increase in investment.



                             Macroeconomic Themes: 2                 5
      Crowding out of Investment:
Equilibrium with Interest Rate Feedback

 The money market equilibrium, LM curve, is
 provided by equation (5) and exogenously fixed
 real money supply
 M  kY  r
 P

 or       1             
      r    kY  M    (7)
                    P

                              r k
 LM is an upward sloping line y    0


                               Macroeconomic Themes: 2   6
 Equilibrium with Price Feedback:
  Model III: Aggregate Demand
                     
                  1  kY  M   G
   a  bT  I  q  
                     
             0               P 
Y                   
                     
                                         ,
                1 b
Solve for Y as

                q
   a  bT  I  M  G
Y           0
               q
                   P             (8)
         1 b  k


                         Macroeconomic Themes: 2   7
   Response of Output to the Fiscal and Monetary
                        Policy

Y   b
T 1 b   q k 0;
           
Y  q   0 and
M 1 b  q k
          
Y  1        0
G 1 b  q k
         

                  Macroeconomic Themes: 2          8
Parametric Specifications for Model I, II and III

                   a                     150
                   b                     0.8
                   T                      50
                   G                      60
                   I0                     50
                   q                      10
                   M                     150
                   P                       1
                   k                     0.8
                   n                   3000
                   r-for                0.05
                   model1
                   Price                   2
                   change



                 Macroeconomic Themes: 2            9
Macroeconomic equilibrium without and with
        interest and price feedback

                Model 1       Model 2      Model 3 Model 4
Y               1097.5       1087.993     1086.349   1085
G-Multipler        5         4.934211     4.934211 4.934211
Consumption      988         980.3947     979.0789    978
Tax               50            50           50        50
G-Spending        60            60           60        60
Investment       49.5        47.59868     47.26974 47.2654
Saving           59.5        57.59868     57.26974     57
Interest rate    0.05        0.240132     0.273026 0.27346
Price level        1             1            3      3.25


                Macroeconomic Themes: 2                  10
             Simple Model of Aggregate supply


Y  L
Labour demand consistent with maximisation of profit:
         1
L   W  1
        
   
   
    1    
         
   
     P  
         

Since labour demand is equal to the labour supply in
equilibrium
                                
               supply: Y   W  1 ; Y  0
                                   
Aggregate                  1
                           
                           
                                    
                                                    the aggregate supply
                           
                            P      
                                     P
is upward sloping.


                               Macroeconomic Themes: 2                  11
      Parametric Specification for the
             Labour Market
a              5487.50      5439.97         5431.74   5425.00
b                 0.50         0.50            0.50      0.50
c              3841.25      3841.25         3841.25   3841.25
d                 0.50         0.50            0.50      0.50
phi               0.75         0.75            0.75      0.75

Note              a=y*5               b=y*3.5



                  Macroeconomic Themes: 2                       12
A Numerical Illustration of the Determination
  of Employment and the real wage rates in
               above models
                 Labour Market
                   5487.50     0.50     0.00     0.50
  a                5487.50 5439.97 5431.74 5425.00
  b                   0.50     0.50     0.50     0.50
  c                3841.25 3841.25 3841.25 3841.25
  d                   0.50     0.50     0.50     0.50
  phi                 0.75     0.75     0.75     0.75
                 Model 1 Model 2 Model 3 Model 4
  Output           1097.50 1087.99 1086.35 1085.00
  Employment      11320.68 11190.13 11167.58 11149.10
  Real wage        1646.25 1598.72 1590.49 1583.75
  Price level         1.00     1.00     1.00     1.00
  Nominal wage     1646.25 1598.72 1590.49 1583.75
                   Macroeconomic Themes: 2              13
        Can you suggest other forms of
              Supply Curves?

References:
1.   Hicks, J. R.(1937): Mr. Keynes and the "Classics"; A Suggested Interpretation,   Econ
     1937.
2.   Mankiw N.G. (1989) Real Business cycle: A New Keynesian Perspective, Journal of Econ
     Perspectives, vol. 3, no. 3 pp. 79-90.
3.   Lucas, Robert Jr. and Sargent, After Keynesian Macroeconomics, Spring 1979, Federal
     Reserve Bank of Monneapolis Quarterly Review.




                                  Macroeconomic Themes: 2                      14

				
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