----------------- HES POSTING ----------------- I share Prof. Lipsey's concerns about US Keynesians using the Y=3DE diagram to derive AD. The 45-degree diagram captures a bit of the Keynesian production dynamics. First, it emphasises that actual production takes place a period ahead, on the basis of anticipated demand for the following period. This is a typical Keynesian feature in contrast to the standard Walrasian model of exchange where actual production and exchange take place simultaneously after the auctioneer announces the equilibrium prices. Second, if the sales expectations are not realised (often possible), firms adjust quantities (from inventories) instead of prices (as in the Walrasian markets) in the next period. Inventories give signals for adjustments in the Keynesian model. In contrast, such signals are given by prices in the Walrasian markets. What is important here is a discussion of the length of these two unit time periods e.g., the Keynesian unit time is much shorter (up to a quarter or two perhaps) than the Walrasian unit time (say of one or two years) over which price adjustments take place. Third, in the following period (period three), firms revise their sales expectations and change their production plans. And this process continues until expected demand and production equal. What is missing here is: when firms may also decide to change prices? The Phillips curve and the mark-up principle provide some answers. The modified DF model (see my previous post) is a sort of synthesis (with both quantity and price adjustments) and gives the impression, perhaps unacceptable to the pure Keynesians, that Keynesian results can be obtained by modifying the Walrasian GE model. In my view, before the DF model is taught, a purely descriptive account of the differences between the Keynesian and Walrasian systems may help students. Perhaps the real world consists of both the Keynesian quantity adjustment and the Walrasian price adjustment markets. Alternatively both quantity and price adjustments take place (in the unit time period) may be treated as a simplifying assumption. The question is: What proportion of the total transactions takes place in such markets? satisfactory answers could throw light on the relevance of the Walrasian and Keynesian approaches to model the macro economy. In a rudimentary attempt (Rao, 1993) it was found that more than 85% of the U.S. GNP transactions take place in the Keynesian markets. If this is further corroborated, the standard ISLM plus the Phillips curve would be adequate for the principles texts. The DF model is a simple diagrammatic variant of this approach. Their AS curve is the commodity market Phillips curve in the P-Y space instead of the inflation-output space. May I say that it would be useful to replace or add to the current complicated diagrammatic expositions, simple numerical dynamic simulations to explain the split between quantity and price changes, for a given change in the so called AD. Perhaps the new generation of textbook writers would consider my suggestion and strengthen the structure and relevance of the macro models, instead of perpetuating confusions between the Keynesian and Walrasian approaches. Reference: Rao, B.Bhaskara., (1995) "The Nature of Transactions in the U.S. Aggregate Goods Market", Economics Letters, pp.385-390. ------------ FOOTER TO HES POSTING ------------ For information, send the message "info HES" to [log in to unmask]