Money Market - Aggregate Supply & Demand

Cambridge Approach

$$\begin{array}{rl}M& =kPy\\ M^d& =k(Py)⟹{\text{Money}}^d=\text{Nominal Income}\\ \Delta M& =\overline{k}p\overline{Y}\end{array}$$

We will talk about the

• Neutrality of money
• Equilibrating money market by price

A policy is said to be effective when it is able to achieve its desired goal.

$$\Delta M=\Delta P\Pi =\text{inflation}$$ $$\Pi =m-g$$

Inflation  = rate of growth of money supply - rate of growth of output

Aggregate supply

More the wage, less the demand

$L^d=\varphi {\left(\frac{W}{P}\right)}_{-}$
$L^S=\varphi {\left(\frac{W}{P}\right)}_{+}$

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Dynamics 1

$$\begin{array}{rl}{M}^S& =3000cr\\ W_1& =6\\ P_1& =2\\ W_1& =\frac{6}{2}=3\end{array}$$

Dynamics 2

$$\begin{array}{rl}{M}^S& =4000cr\\ W_2& =3\\ P_2& =2\\ W_2& =\frac{6}{2}=3\end{array}$$

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Now disequilibrium between $L^d$ and $L^S$

In classical model, disequilibrium doesn’t stay for long. Therefore, firms increase money wage equiproportional to the price level.

Firms increase wage to $9$.

Therefore, $\frac{W}{P}=\frac{9}{3}=3\to \frac{W}{P}\uparrow$ leads to $L^d\downarrow$ and $L^S\uparrow$ at $W_2$ and labor comes to 100 (equilibrium).

The graphs represent the Neutrality of Money.

$$M^S\uparrow \to P\uparrow \to \overline{y}$$

which is equiproportional change in $M^S$ and $P$.

The aggregate supply curve which explains that the levels of output and employment are determined by the supply side factors and not by monetary factors.

Conclusions

• In classical model the aggregate supply curve is in vertical form which means that when the employment is constant, the output also remains constant. $\overline{N}⟹{\overline{y}}_0$
• At a higher level of $(P_1,P_2,P_3)$ price level.
• Due to this we can infer that the monetary policy is not effective. (Because there is no change in output)

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