Download university of maiduguri - Unimaid, Centre for Distance Learning

UNIVERSITY OF MAIDUGURI
MAIDUGURI, NIGERIA
CENTRE FOR DISTANCE
LEARNING
MANAGEMENT SCIENCES
ECON 304:
Unit: 2
ECON
MACROECONOMICS
304:
MACROECONOMICS
UNIT: 2
CDL, University of Maiduguri, Maiduguri
ii
ECON 304:
Unit: 2
MACROECONOMICS
Published
2010©
All rights reserved. No part of this work may be
reproduced in any form, by mimeograph or any other
means without prior permission in writing from the
University of Maiduguri.
This text forms part of the learning package for the
academic
programme
of
the
Centre
for
Distance
Learning, University of Maiduguri.
Further enquiries should be directed to the:
Coordinator
Centre for Distance Learning
University of Maiduguri
P. M. B. 1069
Maiduguri, Nigeria.
This text is being published by the authority of the
Senate, University of Maiduguri, Maiduguri – Nigeria.
ISBN: 978-8133-
CDL, University of Maiduguri, Maiduguri
iii
ECON 304:
Unit: 2
MACROECONOMICS
P R E FA C E
This study unit has been prepared for learners so that they
can do most of the study on their own. The structure of the
study unit is different from that of conventional textbook.
The course writers have made efforts to make the study
material rich enough but learners need to do some extra
reading for further enrichment of the knowledge required.
The learners are expected to make best use of library
facilities and where feasible, use the Internet. References are
provided
to
guide
the
selection
of
reading
materials
required.
The University expresses its profound gratitude to our course
writers and editors for making this possible. Their efforts
CDL, University of Maiduguri, Maiduguri
iv
ECON 304:
Unit: 2
MACROECONOMICS
will no doubt help in improving access to University
education.
Professor M. M. Daura
Vice-Chancellor
CDL, University of Maiduguri, Maiduguri
v
ECON 304:
Unit: 2
MACROECONOMICS
HOW TO STUDY THE UNIT
You are welcome to this study Unit. The unit is
arranged to simplify your study. In each topic of the unit,
we have introduction, objectives, in-text, summary and selfassessment exercise.
The study unit should be 6-8 hours to complete. Tutors
will be available at designated contact centers for tutorial.
The center expects you to plan your work well. Should you
wish to read further you could supplement the study with
more information from the list of references and suggested
readings available in the study unit.
PRACTICE EXERCISES/TESTS
1. Self-Assessment Exercises (SAES)
This is provided at the end of each topic. The exercise
can help you to assess whether or not you have actually
studied and understood the topic. Solutions to the exercises
are provided at the end of the study unit for you to assess
yourself.
CDL, University of Maiduguri, Maiduguri
vi
ECON 304:
Unit: 2
MACROECONOMICS
2. Tutor-Marked Assignment (TMA)
This is provided at the end of the study Unit. It is a
form of examination type questions for you to answer and
send to the center. You are expected to work on your own in
responding to the assignments. The TMA forms part of your
continuous assessment (C.A.) scores, which will be marked
and returned to you. In addition, you will also write an end
of Semester Examination, which will be added to your TMA
scores.
Finally, the center wishes you success as you go through
the different units of your study.
CDL, University of Maiduguri, Maiduguri
vii
ECON 304:
Unit: 2
MACROECONOMICS
INTRODUCTION TO THE COURSE
This study unit is a continuation of learning in the field of macro-economics
from earlier units based on the semester system. The topics that shall be
covered are captured under two broad headings namely;
-
unemployment and inflation and
-
analysis of the IS-LM apparatus
CDL, University of Maiduguri, Maiduguri
1
ECON 304:
Unit: 2
MACROECONOMICS
ECON 304:
MACROECONOMICS
UNIT: 2
TA B LE
O F
C O N TE N T S
PAGES
PREFACE
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
iii
HOW TO STUDY THE UNIT
iv
INTRODUCTION TO THE COURSE
-
1
TOPIC:
1:
UNEMPLOYMENT -
-
3
CDL, University of Maiduguri, Maiduguri
2
ECON 304:
Unit: 2
2:
MACROECONOMICS
INFLATION
-
-
-
-
-
-
THE I / S CURVE -
-
-
-
-
-
4:
THE L / M CURVE
-
-
-
-
-
-
26
5:
EQUILIBRIUM OF PRODUCT AND MONEY
9
3:
21
MARKETS
31
SOLUTIONS TO EXERCISES
CDL, University of Maiduguri, Maiduguri
3
ECON 304:
Unit: 2
MACROECONOMICS
TOPIC 1:
TABLE OF CONTENTS
1.0 TOPIC:
UNEMPLOYMENT
1.1 INTRODUCTION
1.2 OBJECTIVES
1.3 IN-TEXT
1.3.1 Meaning of Unemployment
1.3.2
Types/Causes of Unemployment
1.3.3 Meaning of Full Employment
1.3.4
How to achieve Full Employment
1.3.4
Relationship between unemployment and
output
1.4 SUMMARY
1.5 SELF- ASSESSMENT EXERCISES
CDL, University of Maiduguri, Maiduguri
4
ECON 304:
Unit: 2
MACROECONOMICS
1.6 REFERENCE
1.7 SUGGESTED READINGS
CDL, University of Maiduguri, Maiduguri
5
ECON 304:
Unit: 2
MACROECONOMICS
1.0 TOPIC:
UNEMPLOYMENT
1.1 INTRODUCTION
Unemployment has been one of the most persistent problems facing most
economies of the world. One of the goals of macroeconomic policy is to fight
the scourge of unemployment and achieve full employment. This topic will
attempt to expose the students to the meaning of unemployment, its
type/causes and eventually describe what full employment is all about and
how it can be achieved and maintained in an economy.
1.2 OBJECTIVES:
At the end of this topic students should be able to:
i.
Explain what unemployment is.
ii.
Differentiate between scholars perception of unemployment.
iii.
Differentiate between unemployment and full employment.
iv.
Have knowledge on how to achieve and maintain full employment in
an economy.
v.
Understand the relationship between GDP and unemployment.
1.3 IN-TEXT
1.3.1
Meaning of Unemployment
According to Everymans Dictionary of Economics unemployment refers to
“involuntary idleness of a person who is willing to work at the prevailing rate
of pay but unable to find job. In other words, it refers to a situation where
individuals who are willing and able to work cannot find jobs due to one
reason or the other.
1.3.2
Types/Causes of Unemployment
Generally, unemployment has been classified and named according to the
sources that gave rise to them. The following have been identified:
Frictional Unemployment:
This type of unemployment exists whenever there
is lack of adjustment between demand for and supply of labor. This
may be due to lack of knowledge of existing labor or vacancies on the
part of employers and workers respectively. Frictional unemployment
may also be as a result of lack of necessary expertise for a particular
job, labor immobility, breakdown in production due to different
reasons, waiting period when changing from one job to another or as a
CDL, University of Maiduguri, Maiduguri
6
ECON 304:
Unit: 2
MACROECONOMICS
result of unforeseen circumstances that may disrupt production
following which workers have to stay idle.
Seasonal Unemployment:
This type is directly attributable to seasonal
fluctuation in demand. For instance, the demand for raincoat and
umbrella declines soon after the rainy season. Also, the demand for ice
block generally tends to be lower in the winter. Workers in all such line
of business have less engagement when demand for their product
declines. They are all said to be victims of seasonal unemployment.
Cyclical Unemployment: This is attributed to the ups and downs associated with
business cycles. In other words, cyclical unemployment is said to exist
whenever there is reduced employment activity following a downsizing
of the business cycle.
Structural Unemployment:
This results from a variety of sources. It may be
due to lack of cooperate factors of production, or changes in the
economic structure of the society. It is in other words associated with
massive or extensive restructuring in the consumption pattern of the
society. For example workers in the factories producing the old
fashioned high heel Shoes or Black and White or the Take-and-wash
Camera would have to re-train or remain unemployed as their wares
are no longer in the taste and fashion of the community.
Technological Unemployment: Modern production process is essentially dynamic
where innovations lead to the adoption of new machineries and
inventions thereby displacing existing workers. Technological
unemployment is observed whenever there is automation leading to
less involvement of human labor in production process.
1.3.3
Meaning of Full Employment
The compound wards “full employment is a slippery concept. So
describe by Professor Ackley due to the divergent scholastic views on it.
Hence it is not definable nor should it be defined. Perhaps the controversy on
the concept of full employment full employment is best captured in the wards
of Professor W.W. Hart. “Attempting to define full employment raises many
peoples blood pressure. Rightly so because there is hardly any economist who
does not define it in his own way”
Despite the definitional inconsistencies however, full employment has
been accepted by all scholars as one of the most important goal of
macroeconomic policy. We shall accordingly view some of the major
definitions as follows:
The Classical View
This school of thought sees full-employment as normal. According to
Pigou, one of the greatest proponents of this school of thought, every
economy has a tendency to automatically provide full employment in the labor
CDL, University of Maiduguri, Maiduguri
7
ECON 304:
Unit: 2
MACROECONOMICS
market. Unemployment, according to this school of thought resulted from
interventionist activities such as rigidity in the wage structure and interference
generally in the working of the free market system through trade union
legislation and or minimum wage legislation.
Those who are not prepared to work at the existing wage rate are not
unemployed in the pigouvian sense because they are voluntarily unemployed.
The climax of this contention is that with a perfectly free and competitive
environment, there will always be a strong tendency for wage rates to be so
related to the level of demand that everybody is employed.
The Keynesian View
According to Keynes full employment means absence of involuntary
unemployment. In other wards full employment is a situation in which all
willing and capable hands in an economy have a fairly gainful employment.
Keynes assumes that “with a given organization, equipment and techniques,
real wages and the volume of output (and hence employment) are uniquely corelated, so that in general, an increase in employment can only occur in the
accompaniment of a decline in the rate of wages. In his famous book the
general theory of Employment, Keynes gives additional definition of full
employment thus “ a situation in which aggregate employment is inelastic in
response to an increase in the effective demand for its output” This implied
that the test of full employment is when any further increase in effective
demand is not accompanied by any increase in output. Hence the supply of
output becomes inelastic at the full employment level, and any further increase
in effective demand will lead to inflation in the economy. Thus the Keynesian
view of the concept of full employment is under laid by the prevalence of
three conditions.
i)
reduction in the real wage rate
ii)
increase in effective demand; and
iii)
inelastic supply of output at the level of full
employment
Other Views
Lord Beveridge in his book “full employment in a free society” defined
full employment as a situation where there were more vacant jobs than there
are unemployed men so that normal lag between losing a job and finding
another will be very short. Full employment according to him is not
synonymous to zero unemployment which means that” full employment is
not always full” There is always a certain amount of frictional unemployment
in the economy even when there is full employment. But the notion of more
vacant jobs than the unemployed raises series of questions and hence cannot
be accepted as condition for full employment.
CDL, University of Maiduguri, Maiduguri
8
ECON 304:
Unit: 2
MACROECONOMICS
The American Economic Association Committee sees full employment
to refer to “a situation where qualified individual who seek jobs at the
prevailing wage rate can find them in productive activities without
considerable delays. In other wards it means full time jobs for all people who
want to work full time. It does not mean unemployment is ever zero. Here
again, like Beveridge, the Committee considered full employment to be
consistent with some amount of unemployment.
Individual economists may, however continue to differ in their
understanding of what full employment is, but the majority has centered
round the view of the U N experts on National and International Measure for
full Employment that “ that full employment may be considered as a situation
in which employment cannot be increased by an increase in effective demand
and ……. Does not exceed the minimum allowances that must be made for
the effects of frictional and seasonal factors”
This definition is in line with Keynesian and Beveridgean views. It has
now been agreed that full employment stands for 96 to 97 per cent
employment, with 3 to 4 per cent unemployment existing in the economy due
to frictional factors.
1.3.4
Measures
to
Achieve
and
Maintain
Full
Employment
Since unemployment is caused by deficiency in effective demand, full
employment, according to the Keynesians can be ensured by accelerating
effective demand either by stimulating investment or consumption, or both.
Contemporary trends show that countries of the world use the traditional
policy-mix in ensuring that the economy is fine-tuned towards sustainable
growth consistent with full employment in both the short and long run.
1.3.5 Relationship between Unemployment and Output
hange in Une mplo yme nt
In explaining the relationship between output and unemployment Sir,
Arthur Okun, an economist based in Britain, collected and used a data of over
one century on the performance of certain European countries. He concluded
by pointing out that the level of an economy’s aggregate output as implied by
the GDP has inverse relationship with the level of unemployment. In other
words, Okuns law states that “for every 2% that GDP falls relative to
potential GDP, unemployment rate rises by 1% point”.
This means that if GDP begins at 100% of its potential and fall to 90%, the
rate of unemployment rises by 5%, say from 5% to 10%. This relationship is
depicted in the diagram below.
CDL, University
10 of Maiduguri, Maiduguri
5
Okun Law
9
ECON 304:
Unit: 2
MACROECONOMICS
Implications of the Ukun’s law
- It identifies and explains the vital link between the output market and labour
market.
- It describes the association between short-run movement in real GDP and
changes in unemployment.
- It stresses the fact that actual/real GDP must grow as rapidly as the potential
GDP to keep the rate of unemployment from rising.
- In essence, to maintain the current rate of unemployment, actual GDP has to
keep running in the same face as the potential GDP. In other words, to bring
the rate of unemployment down, actual GDP must be growing faster than the
potential GDP
1.4 SUMMARY
Unemployment has been one of the most persistent problems facing
most economies of the world. One of the goals of macroeconomic policy is to
fight the scourge of unemployment and achieve full employment.
According to Everymans Dictionary of Economics unemployment
refers to “involuntary idleness of a person who is willing to work at the
prevailing rate of pay but unable to find job. In other words, it refers to a
situation where individuals who are willing and able to work cannot find jobs
due to one reason or the other.
Generally unemployment has been classified by type and causes to
include frictional, seasonal cyclical, structural and technological. The concept
of full employment it is shown, differs between different schools of thought.
We have also presented the measures for the achievement and maintenance of
full employment in an economy along side the relationship between
unemployment and output as contained in the work of Sir Arthur Okun.
1.5 SELF ASSESSMENT EXERCISES
1
2.
3
(a)
(b)
State the “OKUN’S LAW”
Mention and briefly explain the relevance of this law to the
Nigerian Economy.
(a)
What is full employment?
(b)
Differentiate between classists and Keynesians contention of
full employment.
Differentiate between Voluntary and Involuntary Unemployment
CDL, University of Maiduguri, Maiduguri
10
ECON 304:
Unit: 2
MACROECONOMICS
1.6 REFERENCES
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
HENDERSON & POOLE (1991)– PRINCIPLES OF ECONOMICS,
Revised Edition, Published 1991. Virinda Publications (P) Ltd.
1.7 SUGGESTED READINGS
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
TOPIC 2:
TABLE OF CONTENTS
2.1
INTRODUCTION
2.2
OBJECTIVES
2.3
IN-TEXT
2.3.1 STRAINS OF INFLATION
2.3.2 TYPES/CAUSES OF INFLATION
2.3.3 STAGFLATION
2.3.4 CAUSES OF STAGFLATION
2.4
SUMMARY
2.5
SELF ASSESSMENT EXERCISES (SAE)
2.6
REFERENCES
2.7
SUGGESTED READINGS
CDL, University of Maiduguri, Maiduguri
11
ECON 304:
Unit: 2
MACROECONOMICS
CDL, University of Maiduguri, Maiduguri
12
ECON 304:
Unit: 2
MACROECONOMICS
2.0 TOPIC:
INFLATION
2.1 INTRODUCTION
The word inflation has been variously defined by scholars depending
on what each perceive to be its causative agents. Thus, economists of different
backgrounds, from the neo-classical to Keynesians and Neo-Keynesians see
inflation differently and hence adopted different approaches and strategies in
remedying its consequential effects. Generally however, two major schools of
thought have been recognized. The neo-classicals and their followers see
inflation as fundamentally a monetary phenomenon. In the wards of
Friedman, “inflation is always and everywhere a monetary phenomenon…and
can be produced only by a more rapid increased in the quantity of money than
in output” But economists of other background do not agree that money
supply alone is the cause of inflation. As pointed out by Hicks “the problems
of inflation are not entirely of a monetary phenomenon” Thus, Economist like
Johnson, Brooman and Shapiro defined inflation differently as “a persistent
and appreciable rise in the general level of prices” Dernberg and McDougall
are more explicit when they write that “the term usually refers to a continuing
rise in prices as measured by an index such as the CPI, PPI or by the implicit
price deflator for Gross National Product.
2.2 OBJECTIVES
At the end of this topic students should be able to:
i.
Explain what inflation is all about.
ii.
Differentiate between different strains of inflation
iii.
Account for the various causes and types of inflation
iv.
Understand the theoretical approaches to the study of inflation
2.3 IN-TEXT
2.3.1
Strains of Inflation
The sustained rise in price with which inflation is identified with may be of
various magnitudes. Hence, inflation has been categorized according to such
magnitude/degree as follows:Creeping Inflation: This is when the rise is very slow like 1-3% per annum.
Scholars generally have agreed that this type of inflation is safe for the
economy and necessary for economic growth.
CDL, University of Maiduguri, Maiduguri
13
ECON 304:
Unit: 2
MACROECONOMICS
Walking/Trotting Inflation: - This is where prices rise moderately at an annual
rate of 3-7% or less than 10%. Inflation at this stage is a warning signal for
policy makers to apply control measures before the situation deteriorates to
the next stage.
Running Inflation: - As the name implies, price rises rapidly at an annual rate of 1020%. Such inflation affects the poor and middle income classes adversely.
Controlling it requires stringent monetary and fiscal measures otherwise it
graduate into galloping inflation.
Galloping Inflation:This is the name give to the type of inflation in which
prices rise at a very fast and double or triple digit rates above 20% (i.e. 20100% or more per annum) Inflation at this stage has a devastating effects on
virtually all spheres of human life
Hyperinflation: - This is the worst form of inflation. It is characterized by a rapid
and immeasurable price rise which is so frequent that public confidence in
money as a means of exchange is completely eroded. Consequently the
monetary system collapses with people resorting to barter goods. The
productive base of the society cease to function as exchange process is
rendered ineffective. On the overall, societal welfare is adversely affected and
unless drastic measures are taken, the entire economy collapse.
Generally, it is not easy to identify a particular country as having experience
any form of inflation. This is because countries are found to withhold or provide
biased information on the status of their inflationary strain. By and large however,
inflation is real and is more predominant in developing economies with its attendant
consequences ravaging the life of the poor and less privilege in society.
2.3.2
Causes/Types of Inflation
a)
Demand Pull Inflation
Otherwise known as excess demand inflation is the traditional and
most common type of inflation. It is called this name because it takes place
when aggregate demand is rising faster than the rise in the level of output. The
failure to expand output in the same proportion as the increase in demand
may be either because resources are fully utilized or production cannot be
increased as rapidly as the increase in aggregate demand. As a result prices
begin to rise in response to a situation often described as “too much money
chasing too few goods”
CDL, University of Maiduguri, Maiduguri
14
ECON 304:
Unit: 2
MACROECONOMICS
Theories of Demand Pull Inflation
The Monetarist View: -
This school of thought emphasis money supply as the
principal cause of demand pull inflation. They buttressed their points using
the simple quantity theory of money as contained in Fisher’s equation of
exchange.
MV=PQ
Where M = Money Supply
V = Velocity of Money
P = Price Level
Q = Level of Real Output
Assuming V and Q as constant, the price level (P) varies in the same
proportion with the supply of money (M).With flexible wages the economy is
believed to be operating at full employment level. The labor force, the capital
stock and technology also changed but only slowly overtime. Consequently,
the amount of money spent did not directly affect the level of real output so
that a doubling of quantity of money simply results in doubling the price level.
Until prices have risen by this proportion, individuals and firms would have
excess cash which they would spend leading to rise in prices. So inflation
proceeds at the same rate at which the money supply expands.
Friedman’s view: - Modern quantity theorists led by Friedman hold that “inflation
is always and everywhere a monetary phenomenon that arises from a more rapid
expansion in the quantity of money than in total output.” They argued that
changes in the quantity of money will work through to cause changes in nominal
income which eventually empowers people to spend more resulting to excess
demand. Friedman also discussed whether increased in money supply first goes
into output or prices. The answer to this question is contained in the following
flow chart:
- Increase in Money Supply
- Increase in Nominal Income
- Increased Demand for Goods and Services
- Increased Demand for Labor
- Higher Wages for Workers
- Higher Input cost
- Higher Prices
- Lower Profit Margins
- Higher prices, again.
At the beginning people will expect the price rise to be temporary, and so they
increase their savings and the price rise therefore will be less than the actual
increase in nominal money supply. Gradually people will readjust their savings.
CDL, University of Maiduguri, Maiduguri
15
ECON 304:
Unit: 2
MACROECONOMICS
Prices at this point rise more than the rise in money supply. Thus according to
Friedman, the monetary expansion mechanism works through output before
inflation starts.
The quantity theory version of demand pull inflation is illustrated
diagrammatically in the figure below:
LM
Interest Rate
(A)
E1
LM 1
R
E1
R1
IS
YF
0
Figure 1.1
Y1
(B)
Price Level
S
E1
E
P1
P
YF
0
E1
D
D1
Y1
Inc om e
Suppose the money supply is increased at a given price level as determined by D and
S curves in panel (B) of the above figure. The initial full employment situation at this price
level is shown by the intersection of IS and LM curves at point E in panel A of the figure.
At this point R is the interest rate and YF is the full employment level of income. With the
increase in the quantity of money the LM curve shift to the right to LM1 and intersects the
IS curve at E1 such that the equilibrium level of income rises to Y1 and the rate of interest is
lowered to R1. As the aggregate supply is assumed to be fixed there is no change in the
position of the IS curve.
Consequently the aggregate demand rises to the right to D1 and thus excess demand
is created of the area EE1 = YFY1 in panel B. This raises the price level as shown by the
vertical portion of the supply curve S. The rise in the price level reduces the real value of the
money supply so that LM 1 curve shift to the left to LM. Excess demand will not be
eliminated until aggregate demand curve D1 cuts the aggregate supply curve S at E. this
means a higher price level P1 and a return to the original equilibrium position E in the
CDL, University of Maiduguri, Maiduguri
16
ECON 304:
Unit: 2
MACROECONOMICS
upper panel of the figure where IS cuts LM curve. The result then is that the price level rises
in exact proportion to the real value of the money supply to its original value.
CDL, University of Maiduguri, Maiduguri
17
ECON 304:
Unit: 2
MACROECONOMICS
Keyne’s Theory of Demand Pull Inflation
This school of thought emphasize that demand pull inflation, as the name
implies, is wholly caused by increase in aggregate demand. Aggregate demand denotes
various forms of demand for goods and services by various agents in the economy.
Thus it comprises all consumption activities by individuals, businesses and
governments at various levels. When the value of all such activities exceeds the value
of aggregate supply at full employment level of output, inflationary gap arises. The
larger the gap between aggregate demand and aggregate supply, the more rapid the
inflation. Given a constant average propensity to save, rising money income at the
full employment level will lead to an excess of aggregate demand over aggregate
supply and to a consequent inflationary gap. The concept of inflationary gap is
further elaborated in the diagram below.
Figure 1.2
AS
LM
E
A
Expenditure
{
0
(C+I+G) = AD
B
450
YF
Y1 Income
As shown on the diagram, YF is the full employment level of income. The 45 degrees line
represents aggregate supply AS, and C+I+G line the desired level of consumption,
investment and government expenditure (or aggregate demand curve). The economy’s
aggregate demand curve (C+I+G) = AD intersects the 45 degrees line (AS) at point E at
the income level 0Y1 which is greater than the full employment income level 0Y F. The
amount by which aggregate demand (YFA) exceeds the aggregate supply (YFB) at the full
employment income level is the inflationary gap. This is AB in the figure. The excess volume
of total spending when resources are fully employed creates inflationary pressures in the
economy which are the result of excess aggregate demand.
CDL, University of Maiduguri, Maiduguri
18
ECON 304:
Unit: 2
MACROECONOMICS
The Keynesian theory of demand pull is based on a short run analysis in which
prices are assumed to be determined by non monetary forces. On the other hand
output is assumed to be more variable and is determined largely by changes in
investment spending. To the Keynesians the relationship between changes in
nominal money income and prices is an indirect one through the rate of interest.
This is simplified in the flaw chart below:
-
-
Increase in Quantity of Money
Decrease in the rate of interest
Increase in Investment
Increase Aggregate Demand
A rise in aggregate demand will first mean an expansion of output and
therefore will not affect prices – if resources are not fully employed.
Where the rise is large enough and too sudden, then it constitutes a bottleneck
as output cannot be immediately expanded even though resources are not fully
utilized. Given this situation, the supply of some factors might be inelastic and
others simply might be in short supply and non-substitutable.
This will lead to increase in marginal cost
Increase in Prices, which is above average cost
This will result to higher profits
Higher wages owing to trade union activity
Diminishing Returns might set-in in some industries
As full employment is reached, elasticity of supply of output falls to zero
Prices continue to rise.
Thus, from the point of view of the Keynesians, so long as there is
unemployment in the economy all the changes in income is in output, and once
there is full employment, all is in prices. This theory is further explained in the
diagram below:
CDL, University of Maiduguri, Maiduguri
19
ECON 304:
Unit: 2
MACROECONOMICS
Figure 1.3
LM1
(A)
Interest Rate
LM
E2
R2
R1
E
1
R
IS1
IS
0
YF
Y1
(B)
Price Level
s
P1
P
0
E2
E
YF
E
1
D
Y1
D
1
In co m e
Suppose the economy is in equilibrium at E where the IS-LM curves intersect with
full employment income level YF and interest rate R, as shown in panel (A) of the above
figure. Corresponding to this situation, the price level is P in the lower panel (B).an increase
in government expenditure will shift the IS curve rightward to IS1 and intersect the LM
curve at E1 when the level of income and the rate of interest rise to Y1 and R1 respectively.
The increase in government expenditure implies an increase in aggregate demand which is
CDL, University of Maiduguri, Maiduguri
20
ECON 304:
Unit: 2
MACROECONOMICS
shown by the upward shift of the demand curve to D1 in the lower panel. This will create
excess demand of the area EE1= YFY1 at the initial price level P. The excess demand will
raise the price level, as aggregate supply of output cannot be increased after the full
employment level. As the price level rises, the real value of money supply falls. This will shift
the LM curve to the left to LM1, such that it cuts the IS1 curve at E2 where equilibrium is
established at the full employment level of income YF, but at a higher interest rate R2 (in
panel A) and a higher price level P1 (in panel B).
Consequently the excess demand caused by the rise in government expenditure
eliminates itself by changes in the real value of money.
b)
Costs Push Inflation
Cost push is caused by wage increases following intense union pressure and
profit increases by employers. This type of inflation was known to exist since
the medieval period was revived in the 1950s as one of the principal causes of
inflation. Otherwise referred to as “New Inflation” it is caused fundamentally
by wage escalation and profit maximization derives of entrepreneur.
The basic cause of this type of inflation is the rise in money wages more rapid
than the rise in productivity of labour. Union activities at times press
employers to grant wage increases in excess of increases in the productivity of
labour, thereby raising the cost of production. As a result employers,
employers review the prices of their products upward. The higher wages paid
to workers enable them to buy as much as before, in spite of higher prices. On
the other hand, the increase in prices induces unions to demand still higher
wage. In this way, the wage-cost spiral continues, thereby leading to cost-push
or wage-push inflation.
Cost-push inflation may be further aggravated by upward adjustment of wages
to compensate for rise in the cost of living index. This may be through the use
of “escalator clause” as provided in contracts with employers which ensures
that workers are compensated each time the cost of living index increases by
specified number of percentage points.
Another cause of cost-push inflation is profit push inflation. Oligopolist and
monopolist firms may raise the price of their products to offset the rise in
labour and production cost so as to earn higher profits. There being imperfect
competition in the case of such firms, they are able to “administer price” of
their products.
The phenomenon of cost push inflation is illustrated in the figure below.
CDL, University of Maiduguri, Maiduguri
21
ECON 304:
Unit: 2
MACROECONOMICS
Figure 1.4
LM1
Interest Rate
(A)
LM
IS1
E1
R1
E
R
IS
0
Y1
YF
(B)
Price Level
S
E1
P
1
S1
P
E
D
S0
0
Y1
Inc om e
YF
First consider panel B of the figure where supply curves S0Sand S1S are shown as increasing
function of the price level up to full employment level of income YF. Given the demand
conditions along D, the supply curve S0 is shown to shift to S1 in response to cost increasing
pressures of oligopolies, unions etc. as a result of rise in money wages. Consequently the
equilibrium position shifts from E to E1 reflecting rise in the price level from P to P1 and
fall in output, employment and income from YF to Y1 level. Now consider the upper panel of
the figure. As the price level rises, the LM curve shifts to the left to LM1 because with the
increase in the price level to P1 the real value of money supply falls. Similarly the IS curve
shifts to the left to IS1 because with the increase in the price level the demand for consumer
goods falls due to the Pigou effect. Accordingly, the equilibrium position shifts from E to E 1
CDL, University of Maiduguri, Maiduguri
22
ECON 304:
Unit: 2
MACROECONOMICS
where the interest rate increases from R to R1, and the output, employment and income
levels fall from the full employment level of YF to Y1.
2.3.3
Stagflation
This new term is added to economic literature in the 1970s. It is a compound
ward made up of “stag” and “flation” derived respectively from stagnation and
inflation. It is used to describe a paradoxical situation in which the economy
experiences unemployment along side of a high rate of inflation. Also known as
inflationary recession, it is measured through the use of the “discomfort index” which
is a combination of the rate of unemployment and the rate of inflation. The
discomfort index is computed using the consumer price index, producer price index
and/or the GDP deflator for GNP.
2.3.4
Causes of stagflation
One of the principal causes of stagflation has been a restriction in the
aggregate supply. A decline in aggregate supply means a reduction in output and
employment and a rise in the price level. This restriction may be due to a restriction
in labour supply which might have been caused by a rise in money wages or by
increased tax rates which reduces work incentive on the part of workers.
When wages rise firms are forced to reduce production and employment.
Consequently, there is fall in real income which finally, reduced purchasing power
and expenditure. Since the decline in consumption will be less than the fall in real
income, there will be excess demand in the market which will push up the price level.
The rise in price level reduces output and employment in the following three ways:- it reduces the real quantity of money, raises interest rates and brings a fall in
investment expenditure.
- It reduces the real value of money balances with the government and the
private sector via the pigou effects which reduces their consumption
expenditure.
- The rise in the price of domestic goods makes exports dearer to foreigners
and makes foreign goods relatively cheaper and hence more attractive to
domestic consumers, thereby adversely affecting domestic output and
employment.
Stagflation may also be caused by increase in indirect taxes. Increased indirect
taxes invariably lead to higher cost of production, higher prices and as a result output
and employment are reduced. Restriction in aggregate supply may also be caused by
external factors such as rise in the world price of food stuff and crude oil.
2.4 SUMMARY
The word inflation has been variously defined by scholars depending on what
each perceive to be its causative agents. Thus, economists of different
CDL, University of Maiduguri, Maiduguri
23
ECON 304:
Unit: 2
MACROECONOMICS
backgrounds, from the neo-classical to Keynesians and Neo-Keynesians see
inflation differently and hence adopted different approaches and strategies in
remedying its consequential effects. Generally however, two major schools of
thought have been recognized. The neo-classicalist and their followers see
inflation as fundamentally a monetary phenomenon. But economists of other
background do not agree that money supply alone is the cause of inflation. As
pointed out by Hicks “the problems of inflation are not entirely of a monetary
phenomenon” Thus, Economist like Johnson, Brooman and Shapiro defined
inflation differently as “a persistent and appreciable rise in the general level of
prices” Dernberg and McDougall are more explicit when they write that “the
term usually refers to a continuing rise in prices as measured by an index such
as the CPI, PPI or by the implicit price deflator for Gross National Product.
Strains of inflation describe the magnitude of rise in the price level.
Hence inflation has been classified on these bases to include Creeping,
Walking, Galloping and Hyperinflation. Also described in this text are theories
of demand pull inflation from different schools of thought. We have also seen
that stagflation refers to a paradoxical situation in which the economy
experiences unemployment along side of a high rate of inflation. Also known
as inflationary recession, it is measured through the use of the “discomfort
index” which is a combination of the rate of unemployment and the rate of
inflation.
2.5 SELF ASSESSMENT EXERCISES
1
2.
3
Expansive demand policy aimed at a low rate of unemployment
might cause a wage – price spiral and an accelerating rate of inflation.
Explain the trade off associated with this policy objective.
Differentiate briefly between each of the following:(a) Stagflation and Hyperinflation
(b) Short Run Philips Curve and Long Run Philips Curve
(c) Classical definition and Keynesian definition of Inflation
a
What is Stagflation?
b
How is Stagflation different from Inflation?
2.6 REFERENCES
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
HENDERSON & POOLE (1991)– PRINCIPLES OF ECONOMICS,
Revised Edition, Published 1991. Virinda Publications (P) Ltd.
2.7 SUGGESTED READINGS
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
CDL, University of Maiduguri, Maiduguri
24
ECON 304:
Unit: 2
MACROECONOMICS
TOPIC 3:
TABLE OF CONTENTS
3.0 TOPIC:
THE IS CURVE
3.1
INTRODUCTION
3.2
OBJECTIVES
3.3
IN-TEXT
3.3.1 THE IS CURVE
3.3.2 GRAPHICAL DERIVATION OF THE IS CURVE
3.3.3 ALGEBRAIC DERIVATION OF THE IS CURVE
3.3.4 SHIFT OF THE IS CURVE
3.4
SUMMARY
3.5
SELF ASSESSMENT EXERCISE (SAE)
3.6
REFERENCES
3.7
SUGGESTED READINGS
CDL, University of Maiduguri, Maiduguri
25
ECON 304:
Unit: 2
MACROECONOMICS
3.0 TOPIC:
THE IS CURVE
3.1 OBJECTIVES
At the end of this topic students are expected to:
i. Know the meaning of the IS Curve
ii. Derive the IS Curve Graphically
iii. Derive the IS Curve Algebraically
iv. Explain the shift of the IS Curve
3.3 IN-TEXT
3.3.1
The IS Curve
The IS curve is the locus of all pairs of income and interest rate for which the
expenditure sector is at equilibrium. That is the expenditure or goods market
equilibrium curve shows combination of interest rates and levels of output such that
planned spending equals income. It is a depiction of the relationship that links the
level of income and interest rate which ensures that aggregate demand (consumption
demand plus investment demand plus government demand) is equal to the level of
income:
Y=C+I+G
3.3.2.
Graphical Derivation of the IS curve
The IS curve which is negatively sloped can be derived as follows:
Figure 1.5
s
s
(C)
(b)
Saving Function
(s= y-c[y])
(Savings=
investment)
0
y
(d)
CDL, University of Maiduguri,
Maiduguri
r
Expenditure Market
Equilibrium
0
I
26
r
(a)
Investm ent
Func tion:
ECON 304:
Unit: 2
MACROECONOMICS
Quadrant (a): This part shows the inverse relationship between investment
and interest rate, hence yielding the marginal efficiency of investment (MEI).
The higher the interest rate the less inclined firms would be to invest and vice
versa.
Quadrant (b): This part shows the savings – investment equality thereby
clearly explaining their relationship. Thus the capability of individuals to save
determines the availability of investment fund which eventually determines the
level of interest rate.
Quadrant (c): Here, the savings schedule – where savings is positively related
to income is shown. The higher the level of ones income, the better up he
becomes in terms of reserving a part of that income as savings.
Quadrant (d): This part is the goods/expenditure market equilibrium yielding
the IS curve as explained above.
3.3.3
Algebraic Derivation of the IS curve
Algebraically the IS curve can be derived using either of two alternative
procedures.
We first assume that income is made up of only consumption and investment,
where investment is dependent on income and interest rate as follows:
Y=C+I
C = a + By
I = I0 + I1Y – I2r
We solve for the endogenous variable, Y, in terms of the exogenous variable, r:
Y = a + By + I0 + I1Y – I2r
Hence
CDL, University of Maiduguri, Maiduguri
27
ECON 304:
Unit: 2
Or
MACROECONOMICS
Y = (a + I0 – I2r)/(1 – b – I1)
1/(1 – b – I1).(a + I0 – I2r)
This expresses the equilibrium level of income as a function of the rate of
interest and it is referred to as the IS curve when shown diagrammatically (part b of
the quadrant).
We can use the equilibrium condition where there is equality between desired
savings and desired investment to arrive at the same algebraic expression
S=I
S = a + (1 – b)Y
I = I0 + I1Y – I2r
Hence
a + (1 – b)Y = I0 + I1Y – I2r
Leading again to: Y = 1/(1 – b – I1).(a + I0 – I2r)
This again is the IS curve.
3.2.4
Shift of the IS Curve
A shift of the IS curve from its original location either to the left or right
implies a different level of income and interest rate for the economy. As shown in the
figure below, a shift from IS1 to IS2 implies a higher interest rate and higher level of
income; while a shift inward, from IS2 to IS1 would imply a lower interest rate and
thus lower level of income.
Figure 1.6
CDL, University of Maiduguri, Maiduguri
28
ECON 304:
Unit: 2
MACROECONOMICS
3.4 SUMMARY
The IS curve is the locus of all pairs of income and interest rate for which the
expenditure sector is at equilibrium. That is the expenditure or goods market
equilibrium curve shows combination of interest rates and levels of output
such that planned spending equals income.
We have noted also that the IS curve can be drawn both graphically and
diagrammatically and that the shift of the curve either to the left or right
implies a new level of income for the economy as a whole.
3.5 SELF ASSESSMENT EXERCISES
1.
2
3.
With the use of an appropriate diagram show how a shift of the IS
curve outward can affect the level of interest rate in an economy
a.
Define the IS curve.
b.
Show how it can be derived graphically and algebraically.
What is the likely implication of additional government spending in an
economy?
3.6 REFERENCES
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
HENDERSON & POOLE (1991)– PRINCIPLES OF ECONOMICS,
Revised Edition, Published 1991. Virinda Publications (P) Ltd.
3.7 SUGGESTED READINGS
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
CDL, University of Maiduguri, Maiduguri
29
ECON 304:
Unit: 2
MACROECONOMICS
TOPIC 4:
TABLE OF CONTENTS
4.0
TOPIC:
THE LM CURVE
4.1
INTRODUCTION
4.2
OBJECTIVES
4.3
IN-TEXT
4.3.1 MEANING OF THE LM CURVE
4.3.2 GRAPHICAL DERIVATION OF THE LM CURVE
4.3.3 ALGEBRAIC DERIVATION OF THE LM CURVE
4.3.4 SHIFT OF THE LM CURVE
4.4
SUMMARY
4.5
SELF ASSESSMENT EXERCISES (SAE)
4.6
REFERENCES
4.7
SUGGESTED READINGS
CDL, University of Maiduguri, Maiduguri
30
ECON 304:
Unit: 2
MACROECONOMICS
4.0 TOPIC:
THE LM CURVE
4.2 OBJECTIVES
At the end of this topic students are expected to:
i.
ii.
iii.
iv.
Know the meaning of the LM Curve
Derive the LM Curve Graphically
Derive the LM Curve Algebraically
Explain the shift of the LM Curve
4.3 IN-TEXT
4.3.1
Meaning of the LM Curve
This is the locus of all pairs of income and interest rates for which the
monetary sector is at equilibrium or for which the demand for money is equal to its
supply. That is the relationship between the rate of interest and the level of income
that makes the demand for money equals to the supply of money. Thus, along the
LM schedule, the money market is in equilibrium.
The LM curve is positively sloped such that an increase in interest rate reduces
the demand for real balances. To maintain the demand for real balances equal to the
fixed money supply, the level of income has to rise. In the same vein, money market
equilibrium implies that an increase in the interest rate is accompanied by an increase
in the level of income.
4.3.2.
Graphical Derivation of the LM curve
Graphically the LM curve can be drawn as shown in the figure below:
CDL, University of Maiduguri, Maiduguri
31
ECON 304:
Unit: 2
MACROECONOMICS
Figure 1.7
M1
M1
S
(a )
(b )
Tra nsa ctions
Mo ney Dem a nd :
MI= L[Y]
Mo ney Sup p ly:
Ms= MI+ M2.
y
0
r
LM
r
(D)
Mo ney Ma rke t
Equ ilibrium :
Ms= L[Y]+ L[r]= Md
0
y
M2
0
(a )
Liq uidity
Pre fe re nc e:
M2= L[r] or
Sp e culative Mo ney
Dem a nd
M2
0
M2
Quadrant (a): Here, speculative demand for money is shown as a
function of the level of interest, revealing individuals liquidity preference.
Quadrant (b): In this quadrant the total money supply is shown as
negatively sloping, made up of M1 and M2, respectively for transaction
and speculative demand.
Quadrant (c): This quadrant shows the relationship between transaction
demand and income. The positive slope indicates that individuals
transaction demand increases with the level of income and vice versa.
Quadrant (d): The money market equilibrium is demonstrated as the
equality between money demand and money supply and hence yielding
the LM curve.
CDL, University of Maiduguri, Maiduguri
32
ECON 304:
Unit: 2
MACROECONOMICS
CDL, University of Maiduguri, Maiduguri
33
ECON 304:
Unit: 2
MACROECONOMICS
4.3.3
Algebraic Derivation of the LM curve
Algebraically for the money market to be in equilibrium, we require that
money demand equals money supply:
MS = Md or
MS0 =L0 + L1Y – L2r
Such that solving for (r) in terms of Y gives
r = (MS0 + L0 + L1Y)/L2
This equation expresses the equilibrium rate of interest as a function of the
level of income and its graph is called the LM Curve as shown by the quadrant
(d) in the figure above.
4.3.4
Shift of the LM Curve
A shift of the LM curve from its original location either to the left or
right implies a different level of income and interest rate for the economy. As
shown in the figure below, a shift from LM1 to LM2 implies a lower interest rate
and higher level of income; while a shift inward, from LM2 to LM1 would imply
a higher interest rate and thus lower level of income.
Figure 1.8
LM1
r
LM 2
r1
r2
IS
0
CDL, University of Maiduguri, Maiduguri
Y1
Y2
Y
34
ECON 304:
Unit: 2
MACROECONOMICS
CDL, University of Maiduguri, Maiduguri
35
ECON 304:
Unit: 2
MACROECONOMICS
4.4 SUMMARY
The LM curve is positively sloped such that an increase in interest rate
reduces the demand for real balances. To maintain the demand for real
balances equal to the fixed money supply, the level of income has to rise. In
the same vein, money market equilibrium implies that an increase in the
interest rate is accompanied by an increase in the level of income.
The LM curve is positively sloped such that an increase in interest rate
reduces the demand for real balances. To maintain the demand for real
balances equal to the fixed money supply, the level of income has to rise. In
the same vein, money market equilibrium implies that an increase in the
interest rate is accompanied by an increase in the level of income.
The movements of the LM curve either to the right or left indicate a
new level of income for the economy as a whole.
4.5 SELF ASSESSMENT EXERCISES
1.
2
3.
With the use of an appropriate diagram show how a shift of the LM
curve outward can affect the level of interest rate in an economy
a.
Define the LM curve.
b.
Show how it can be derived graphically and algebraically.
What is the likely implication of a higher interest rate on the level of
output in an economy?
4.6 REFERENCES
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
HENDERSON & POOLE (1991)– PRINCIPLES OF ECONOMICS,
Revised Edition, Published 1991. Virinda Publications (P) Ltd.
4.7 SUGGESTED READINGS
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
CDL, University of Maiduguri, Maiduguri
36
ECON 304:
Unit: 2
MACROECONOMICS
TOPIC 5:
TABLE OF CONTENTS
5.0
TOPIC:
EQUILLIBRIUM OF PRODUCT AND MONEY MARKET
5.1
INTRODUCTION
5.2
OBJECTIVES
5.3
IN-TEXT
5.3.1 IS- LM CURVE INTERSECTION
5.3.2 EFFECTS OF CHANGES IN FISCAL POLICY
5.3.3 EFFECTS OF CHANGES IN MONETARY POLICY
5.4
SUMMARY
5.5
SELF ASSESSMENT EXERCISE (SAE)
5.6
REFERENCES
5.7
SUGGESTED READINGS
CDL, University of Maiduguri, Maiduguri
37
ECON 304:
Unit: 2
MACROECONOMICS
5.0 TOPIC:
THE MONEY AND PRODUCT MARKET
EQUILIBRIUM
5.1
INTRODUCTION
The IS-LM framework or the “Hicks-Hansen” framework was an apparatus
developed by John R. Hicks in 1937 and popularized later in 1949 by Alvin
Hansen. It is an attempt to put the classical – Keynesian argument on the
efficacy of fiscal and monetary policy in proper perspective. The apparatus has
developed to be the core of modern macroeconomics and is a key analytical
tool of the mainstream neo-Keynesian school. The IS-LM framework has also
become the bases of understanding the adjustment process and the interaction
of the money and expenditure markets.
5.2 OBJECTIVES
At the end of this task students are expected to
i.
know how to apply the IS-LM curve studied in the previous section to
practical situation.
5.3 IN-TEXT
5.3.1
IS-LM Curve Intersection
Sir John R. Hicks combined the neoclassical and Keynesian formulations to
develop the IS-LM framework. In simple terms, the IS-LM framework refers to the
locus of all pairs of income and interest rates for which both the expenditure and
monetary sectors are simultaneously in equilibrium.
The IS-LM framework lays emphasis on the interaction between the
expenditure and money markets. Here, spending, interest rates, and income are
determined jointly by equilibrium in the expenditure and money markets.
CDL, University of Maiduguri, Maiduguri
38
ECON 304:
Unit: 2
MACROECONOMICS
The IS and LM curves earlier derived are brought together and shown in one
diagram below:
CDL, University of Maiduguri, Maiduguri
39
ECON 304:
Unit: 2
MACROECONOMICS
Figure 1.9
LM
r
E
re
IS
0
Ye
Y
Since the IS curve slopes downwards and the LM curve slopes upwards, the
two curves intersect in just one point, at r 0 and Y0, depicted by “e” in the figure
above. At this point, two conditions for equilibrium are simultaneously satisfied.
First, planned savings equals planned investment. Second, the stock of money in
existence equals to the stock of money demanded in the economy. The interest rate r0
and income level Y0 represent the only point at which those two equilibria are
simultaneously satisfied. This position is the equilibrium level of income and interest
rate in the Hicks-Hansen framework or neoclassical synthesis.
5.3.2
Effects of Changes in Fiscal Policy
An increase in government spending generally, or a tax cut will shift the IS
curve from IS1 to IS2, implying a higher level of income (Y1 to Y2) and a higher
interest rate (r1 to r2). See figure below:
CDL, University of Maiduguri, Maiduguri
40
ECON 304:
Unit: 2
MACROECONOMICS
Figure 1.10
Note that the flatter the LM curve, the more pronounced will be the
effects of a fiscal policy change on income and the smaller on the level of
interest. On the extreme, a horizontal LM curve will give rise to the highest
possible expansion in income and a zero change in the level of interest. Think
of how the situation will look like if the LM curve were to be vertical.
On the other hand, the flatter the IS curve, the smaller will be the
effect of fiscal policy on both interest rate and income.
5.3.3
Effects of Changes in Monetary Policy
A rise in the money stock shifts the LM curve to the right, lowering the rate of
interest and raising the level of income. See figure below:
CDL, University of Maiduguri, Maiduguri
41
ECON 304:
Unit: 2
MACROECONOMICS
Figure 1.11
Also, the flatter the IS curve, the more pronounced will be the effects
of a change in money stock on the level of income, and the smaller on the rate
of interest. A horizontal IS curve therefore will give rise to the highest
possible expansion in income and leave the interest rate unchanged. Can you
think of the effects of a change in money stock on interest rate and income
where the IS curve is vertical?
To conclude this analysis, the steeper the LM curve, the bigger will be
the effects of a change in the money supply on both the level of income and
the rate of interest.
5.4 SUMMARY
The IS-LM framework or the “Hicks-Hansen” framework was an
apparatus developed by John R. Hicks in 1937 and popularized later in 1949
by Alvin Hansen. It is an attempt to put the classical – Keynesian argument on
the efficacy of fiscal and monetary policy in proper perspective. The apparatus
has developed to be the core of modern macroeconomics and is a key
analytical tool of the mainstream neo-Keynesian school.
Since the IS curve slopes downwards and the LM curve slopes
upwards, the two curves intersect in just one point At this point, two
conditions for equilibrium are simultaneously satisfied. First, planned savings
equals planned investment. Second, the stock of money in existence equals to
the stock of money demanded in the economy.
CDL, University of Maiduguri, Maiduguri
42
ECON 304:
Unit: 2
MACROECONOMICS
This position is the equilibrium level of income and interest rate in the
Hicks-Hansen framework or neoclassical synthesis.
5.5 SELF ASSESSMENT EXERCISES
1
(a)
(b)
What is the IS-LM frame work?
Algebraically and graphically derive the IS and LM curves.
5.6 REFERENCES
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
HENDERSON & POOLE (1991)– PRINCIPLES OF ECONOMICS,
Revised Edition, Published 1991. Virinda Publications (P) Ltd.
5.7 SUGGESTED READINGS
M. L. JHINGAN (1997)– MACRO ECONOMIC THEORY, 11TH Revised
Edition, published 2007, Punjabi Publication, India.
CDL, University of Maiduguri, Maiduguri
43
ECON 304:
Unit: 2
MACROECONOMICS
SOLUTIONS TO EXERCISE
TOPIC 1
TOPIC 2
TOPIC 3
TOPIC 4
TOPIC 5
CDL, University of Maiduguri, Maiduguri
44
ECON 304:
Unit: 2
MACROECONOMICS
TUTOR-MARKET ASSIGNMENT (TMA)
CDL, University of Maiduguri, Maiduguri
45