"Life Cycle" Hypothesis of Saving: Aggregate ... - Arabictrader.com

The Keynesian Gospel According to Modigliani 329
Q
q¢
SS
q*
p“ p* p¢
DD
P
Figure 15.1
Supply and Demand in competitive markets
along the vertical axes and price, p, along the horizontal axes. It normally falls
from left to right since we except the quantity bought to be smaller the higher its
price. SS represents the supply curve (function)—a schedule of the quantity
offered at different prices—that typically rises as price increases. The basic classical
proposition is that in each (competitive) market the price and quantity tend
to a stable equilibrium value given by the coordinates of the point of intersection
of the demand and supply curves, labeled q* and p* in figure 15.1, where demand
equal supply (the “market clears”).
This conclusion rests on a fundamental assumption or postulate, which may be
labeled the “postulate of price flexibility” (The Postulate). It states that, if at any
given market price, the supply exceeds the demand, as at p¢ in the figure, then
the unsatisfied suppliers, unable to sell at least part of what they intended, will
endeavor to sell their unsold supply by bidding the price down toward the equilibrium
value, p*, as shown by the arrow pointing toward the left on the horizontal
axis. This movement will persist as long as p¢ will exceed p* and q¢ is
above q*. A similar mechanism operates when the price is below p*, like p≤ in
figure 15.1, and the quantity demanded exceeds that supplied: the unsatisfied
would-be buyers will bid the price up. Therefore, provided the postulate of price
flexibility holds, equilibrium can be described as a situation where the price and
quantity comes to rest, or where demand equals supply (because only there can
price and quantity come to rest).
I.2 Money Market Equilibrium and the Monetary Mechanism
In an economy that relies on money (rather than barter) to carry out transactions,
(as most economies do today), one of the relevant markets—and an exceedingly