Here's a lecture about ISLM and effective demand.

1. EC4006
Effective Demand and IS-LM
Stephen Kinsella | stephen.kinsell@ul.ie | stephenkinsella.net

2. So Far
Outline of Macroeconomics
History & Development of the Subject
IS-LM

3. IS-LM
Developed by Hicks (1937) and others
Simple, BOE calculating Model (or is it?)
Lots of Problems:
Long Run/Short Run
Aggregation Problems
Idea of ‘One’ Interest Rate
‘Dark Forces of Time & Ignorance’

4. Demo

5. Today
ISLM & Effective Demand (ED)
Message: Output of Economy
Depends on Components of ED

6. Effective Demand
Assume there are N workers, and a static production technology.
Let’s describe the calculations of the Firm.
Value of Output - (Factor Cost + User Cost) = Profit of Firm
Firm wants to Max(Profit)

7. Now from Economy’s POV:
Aggregate income is Factor Cost + Profit
Aggregate Supply Function (ASF) is expectation of
proceeds from employment of resources in this way.
ASF = f(N), where N = No. of Workers
Aggregate Demand Function (ASD) is expectation of
proceeds from employing N workers.
ASD = f(N).

8. When ADF > ASF, employ more people
When ADF < ASF, fire people
@ ADF = ASF, entrepreneurs' expectation of
profits will be maximised

9. Big Questions
Does Supply create Demand
Or, does Demand create Supply?

10. Dynamics
If N goes up, Ag. Income goes up,
Consumption goes up.
Need increasing investment to absorb this
So eqm. level of employment depends on
level of investment
What changes investment? Marginal
Efficiency of Capital (MEC)

11. Summary
Income depends on employment of N
workers
income/consumption relationship depends
on propensity to consume, call this IC
income/investment relationship depends on
MEC
Sum of IC and MEC is effective demand

12. Even better Summary
The volume of employment in equilibrium
depends on
(i) the aggregate supply function, ASF
(ii) the propensity to consume, IC, and
(iii) the volume of investment

13. Let’s think about
Ireland Right Now
Real GDP dropping at 4-6%
Deflation 2-4%
UE running at 11%, so far this year,
expectations much higher
Domestic investment in toilet.
Where is effective demand?

14. Put ISLM and Effective
Demand Together

15. Next Time
Employment and Money
Read Article on Public Folders
Expect Sample Exam next Friday