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.