A simple model of employment, money and prices in a growing economy

Abstract

Introduction The purpose of this article is to develop a simple aggregative model which may be used to study both the problem of reducing short period fluctuations of an economy and the problem of attaining longer term objectives relating to employment, the price level and growth. To do this the Keynesian model of employment, interest and money is extended in a number of ways. The concept of ‘normal capacity output’ is introduced, with the hypothesis that normal capacity output increases continuously as a result of investment in improving productive resources. Actual output is then expressed as a proportion of normal capacity output. The rate of change of the price level is assumed to depend on the ratio of actual output to normal capacity output and on the rate of change of productivity. The rate of interest is assumed to depend on the quantity of money, actual output and the price level. Investment demand is made a function of the ratio of actual output to normal capacity output, the expected rate of growth and the rate of interest. By defining some variables in the model to be either logarithms or ratios of the usual economic variables, assuming continuously distributed time lags in the behaviour relations and making certain linear approximations, which should be satisfactory for moderate fluctuations in output and employment, the model can be written as a system of linear differential equations.

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