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

The Keynesian Gospel According to Modigliani 341
M
MM
M s
a
Figure 15.3
Classical Money demand (fixed Price level)
X“ X* X‘ X
It is evident from (15.4) that, assuming for the moment that k is a constant,
(in line with the classical model), at a given time the quantity demanded depends
only on the level of Real Income, X. The demand function is reported in figure
15.3 as the straight line MM with slope of kP 0 . On the vertical axis we have
marked with X¯ the output corresponding to full employment of the labor force.
The money supply can again be considered as exogenous, and therefore in figure
15.3 is represented as an horizontal line at the height M s . The equilibrium of the
Money market is given by the condition that the demand for money equal the
supply, or zero excess demand
s
KP X - M = 0
0
But since KP 0 , and M s are exogenously given at any point of time, it is apparent
that the only variable that affects the excess demand is output X. Thus the
money market is cleared not by the classical price level, but by output. The market
clearing output is given by
X * s
M P V
= ( )
0
(15.5)
Graphically the money market reaches a Keynesian equilibrium at a point (a)
where the demand for money equals the supply or existing stock. In the graph
the equilibrium income, X* is below the full employment income, X≤; nevertheless
(a) represents an equilibrium because, in the money market, the demand for
and the supply of money are equal, while in the labor market there is unemployment
or excess supply, but because of wage rigidity, the wage and hence P
is stationary. Thus X* can be characterized as a Keynesian under-employment
equilibrium.
But to establish that X* is indeed an “equilibrium,” stable, and unique it is
not enough to show that, at that level of output, the demand and supply of money