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Simultaneous Integration of Product and Money Markets

Exploring the Relationship between Interest Rate and Income

Introduction

  • Model J1930: Reflects on the simultaneous integration of product and money markets.
  • Sectors integration: Product market key, money market key.
  • Equilibrium: Saving = Investment and Aggregate demand = Aggregate supply.
  • Negative relationship: Rate of interest and income, rate of interest and investment.

Equations for Two-Sector Model

  • C + I: Consumption + Investment.
  • I = S: Investment equals saving.
  • C + I + G: Consumption + Investment + Government expenditure.
  • C + I + G + X - M: Consumption + Investment + Government expenditure + Exports - Imports.

Relationship between Interest Rate and Income

  • Negative relationship: Rate of interest and income.
  • Positive relationship: Rate of interest and investment.
  • Positive relationship: Rate of interest and consumption.
  • Positive relationship: Rate of interest and government expenditure.

Liquidity of Money

  • Money demand is the function of income and rate of interest.
  • Is curve and L curve: Income and rate of interest on the axes.
  • Positive relationship: Income and rate of interest for money demand.
  • Negative relationship: Price level and money demand.

Effectiveness of Fiscal and Monetary Policy

  • Effective fiscal policy: Steeper L curve.
  • Effective monetary policy: Steeper Is curve.
  • Fiscal policy: Shifts L curve, contraction or expansion.
  • Monetary policy: Shifts Is curve, contraction or expansion.

Conclusion

  • Steeper curves: More effective policies.
  • Vertical L curve: Totally effective monetary policy.
  • Horizontal L curve: Less effective fiscal policy.

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