An Introduction to Demand Management, Long-Run Growth and Global Economic Governance
Chapter 8: Eartheconomic Demand and Supply
This chapter brings together the building blocks that were developed in the previous chapters and combines the IS curve (equilibrium in the market for goods and services) and the LM curve (equilibrium in the money market) in order to arrive at a relationship between the general price level and the level of production for which the two markets are both simultaneously in equilibrium. This relationship describes how eartheconomic demand responds to the general price level. Next we develop the eartheconomic supply schedule (Section 8.3) and combine it with the demand side in Section 8.4 (see Diagram 8.1). 8.1 DEMAND SIDE EQUILIBRIUM: I=S AND L=M Now that we have studied product market equilibrium (I=S) and money market equilibrium (L=M) we can move on and see what it means if the economy meets these requirements simultaneously. Consider Diagram 8.2 which shows the IS curve and the LM curve in (y , R ) space. In point E we have both product market equilibrium (point E is on the IS curve) and money market equilibrium (point E is on the LM curve). The first thing to do is to check if this is a stable equilibrium. Points to the right (left) of the IS curve are characterized by a situation in which investment exceeds (is less than) planned investment so that inventories increase above (decrease below) desired levels and firms cut (increase) their production. Points above (below) the LM curve are characterized by excess supply of (demand for) money and this drives down (up) the interest rate. The equilibrium is thus stable.
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