AGGREGATE DEMAND AND SUPPLY Also by B. Bhaskara Rao COINTEGRATION FOR THE APPLIED ECONOMIST (editor) THE ECONOMETRICS OF DISEQUILIBRIUM MODELS (co-author) Aggregate Demand and Supply A Critique of Orthodox Macroeconomic Modelling Edited by B. Bhaskara Rao Associate Professor and Director of Postgraduate Studies School ofE conomics University ofN ew South Wales First published in Oreat Britain 1998 by MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire R021 6XS and London Companies and representatives throughout the world A catalogue record for this book is available from the British Library. ISBN 978-1-349-26295-3 ISBN 978-1-349-26293-9 (eBook) DOI 10.1007/978-1-349-26293-9 First published in the Uni ted States of America 1998 by ST. MARTIN'S PRESS, INC .. Scholarly and Reference Division, 175 Fifth Avenue, New York, N.Y. 10010 ISBN 978-1-349-26295-3 Library of Congress Cataloging-in-Publication Data Aggregate demand and supply : a critique of orthodox macroeconomic modelling I edited by B. Bhaskara Rao. p. cm. Includes bibliographical references and index. ISBN 978-1-349-26295-3 1. Demand (Economic theory) 2. Supply and demand. I. Bhaskara Rao, B., 1939- . HB842.E85 1998 338.5'21-DC21 97-18334 CIP Selection, editorial matter and Chapters I and 4 © B. Bhaskara Rao 1998 Chapters 2, 3, 5-11 inclusive © Macmillan Press Ltd 1998 Softcover reprinto fthe hardcover Ist edition 1998 978-0-333-69147-2 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W I P 9HE. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. 10987654 3 2 I 07 06 05 04 03 02 01 00 99 98 Contents Preface xi Notes on the Contributors xiii 1. Introduction 1 B. Bhaskara Rao 2. Aggregate Demand in Principles Textbooks Ken McCormick and Janet M. Rives 2.1 Introduction 11 2.2 Current Textbook Presentations 11 2.3 Other Effects of Price Changes 17 2.4 Additional Considerations 19 2.5 The Need for Alternatives 21 3. Aggregate Demand Curves: A Guide to Use and Abuse Revisited Peter H. Hall and Malcolm L. Treadgold 3.1 Introduction 25 3.2 The Conventional Curve 26 3.3 Problems with the Conventional Approach 28 3.3.1 The Volume of Real Aggregate Demand 28 3.3.2 The Measurement of Excess Demand/Supply 30 3.3.3 Interdependence of Aggregate Demand and Supply 31 vi Contents 3.4 Two Alternatives 33 3.4.1 Rowan's Curve 33 3.4.2 Corden's Constant-MV Curve 39 3.5 Conclusion 42 4. What is the Matter with Aggregate Demand and Supply? B. Bhaskara Rao 4.1 Introduction 45 4.2 Aggregate Demand, Supply and the ISLM Model 46 4.3 The Neo Classical Version 56 4.4 The Keynesian Approach 60 4.5 Conclusions 65 5. Walrasian, Non-Walrasian and Post-Walrasian Perspectives on the ADAS Model: Theoretical and Pedagogical Implications Ralph C. Allen and Jack H. Stone 5.1 Introduction 67 5.2 Institutional Environment 68 5.3 Institutional Environment Behind ISLM 70 5.4 Inconsistencies in ADAS and Proposed Alternatives 72 5.5 Post-Walrasian Coordination in ADAS 76 5.6 Conclusion 80 Contents vii 6. The ADAS Model: Two into One Won't Go Roy H. Grieve 6.1 Introduction 83 6.2 The Textbook Model 84 6.3 Two Theories, One Model: No Go 88 6.4 The Root of the Problem 90 6.5 Conclusion 93 6.6 Postscript 94 7. Defending ADAS: A Perspective on the ADAS Controversy Peter Kennedy 7.1 Introduction 95 7.2 The Rise of ADAS 95 7.3 No Internal Inconsistency 97 7.4 ADAS Can be Confusing 99 7.5 Dynamics 102 7.6 Conclusion 104 Appendix to Chapter 7: Survey Instrument 105 8. Theoretical Inconsistencies in the ADAS Model: Can the Model be Rehabilitated? T. Windsor Fields and William R. Hart 8.1 Introduction 107 8.2 The Textbook ADAS Model 110 8.3 The Aggregate Demand Curve 112 8.4 A Theoretically Consistent ADAS Model 116 8.5 Short Run Aggregate Demand 126 viii Contents 8.6 Price Level and Interest Rate Determination in ADAS Model 128 8.7 Conclusion 135 9. Acceptable and Unacceptable Dirty Pedagogy: The Case of ADAS David Colander and Peter Sephton 9.1 Introduction 137 9.2 What the ADAS Model is Supposed to Accomplish 138 9.3 Problems with ADAS Analysis 138 9.4 Macro Policy Model 142 9.4.1 The Renaming of the AED Curve 143 9.4.2 Using an Aggregate Supply Path Rather than a Supply Curve 144 9.5 The Aggregate Supply Path Alternative 151 9.6 The More Limited Applicability of the Macro Policy Model 152 9.7 Summary 153 10 Aggregate Demand and Supply Analysis: A Story in the Wrong Language John W. Nevile 10.1 Introduction 155 10.2 Language of General Equilibrium Comparative Statics 157 10.3 Marshallian Analysis versus General Equilibrium 162 10.4 Not only the Wrong Language but an Unfamiliar Dialect 166 10.5 A Possible Alternative 168 10.6 Conclusion 174 Contents ix 11 A Simple Analysis of Price and Output Determination: A Model with Imperfect Competition Corrado Benassi, Alessandra Chirco and Caterina Colombo 11.1 Introduction 177 11.2 Aggregate Demand and Supply Under Imperfect Competition 180 11.3 The Role of Wage Rigidities 182 11.4 A Macromodel of Imperfect Competition 185 11.4.1 Firm's Behaviour 185 11.4.2 Union's Behaviour 187 11.5 Aggregate Behaviour of Firms and Unions 189 11.6 Equilibrium Under Full Nominal Flexibility 191 11.6.1 Determination and Properties of Equilibrium 191 11.6.2 Aggregate Demand and Aggregate Supply Under Full Flexibility 195 11.7 Equilibrium Under Nominal Rigidities 195 11.7.1 Equilibrium Under Nominal Wage Rigidity 297 11.7.2 Aggregate Demand and Supply Under Nominal Wage Rigidity 198 11.7.3 Equilibrium Under Nominal Price Rigidity 200 11.8 Concluding Remarks 202 Appendix to Chapter 11 205 Bibliography 209 Index 223