Chapter 3 Summary

Outside money specifically refers to Government money. It is issued by public institutions. Inside money refers to Institutions outside the government realm relating to lending activities. The construction of a monetary economy makes some simplifying assumptions. It postulates that private money does not exist; purely for illustration purposes. Model SIM tests the affects of changing exogenous variables affect the endogenous variables.


Model SIM makes the following assumptions about the economy;


Closed economy.


No imports or exports.


Producers of services have no cost of production & no equipment. Production only carried out by labour.


Inventories do not exist.


No banks, firms or profits.


Government issues money which is legal tender. Used for exchange of good and services in the economy.


Government fixes price of labour per hours.


Unlimited supply of labour.


Demand led economy.


The Model SIM balance sheet has one item, money (H). Household (+) and government (-). Producers do not hold cash. Inflows (+) and outflows (-) cancel each other, therefore summing to zero. Wages are sole source of income for household; can be used for 1) taxes (T) 2) consumer services(C) 3) financial assets (∆ H)


Total production (Y) is expressed as Y== C+G=WB (sum of all expenditure)


There are a number of equations that underpin model SIM. They look to explain how both supply and demand react. Equations are offered to explain how price increases causes a decrease in demand. Firms have an excess of stock to meet demand that may arise. Keynesian approach assumes that supply reacts instantly to demand and completes the order instantly. It is also assumed that Investment must be exactly equal to saving.


The pitfalls of the traditional view of the multiplier effect are outlined. It deals with how flows were considered but not the reaction to stocks from these flows. It is a short run phenomenon and cannot be considered to exist in the long run.


The steady state assumes that flows and stocks are in a continuous rate of change. Either in stationary state, recession or growth the variables remain constant. Model SIM assumes the stationary state. It assumes that consumption must be the same as the available disposable income. The consumption function is adjusted tobe interpreted as a wealth accumulation function.


The model SIM uses the assumption that consumers have perfect foresight regarding their income. It assumes that households make some estimate on their income. Demand is added to the equation as households decide at the beginning of a period how much money they desire to have at the end of the period.


∆Hd = Hd – Hh-1 = YDe - Cd


If realised income is greater than that expected then household will hold the difference in larger cash money balances. The amount of cash held will be similar to that planned but will be modified by an error in their expectations. The difference between desired and realised holdings of money is equal to the expected and realised disposable income. Over time people change their consumption decisions due to unexpected changes in their wealth stock. The fact that expected income is used by the equation rather than realised income means that the system is recursive. If income is continually higher than expected then wealth will in turn be higher than expected causing consumption to grow.


Current income is established by the amount of money that was held in the previous period thus giving credence to Keynes’s argument that money is the link between each period and the next.
A rise in the tendency to consume from current income causes an initial rise in national income due to an increase in consumption expenditure. This will be cancelled out by a decline in accumulated money balances and therefore reduce consumption expenditure out of wealth.


It is sometimes assumed that the process of economic adjustments inevitably lead to an equilibrium. Stability analysis tests whether equilibrium can be attained.


As the SIM model is so simple it is possible to provide a more conventional graphical representation requiring four quadrants fully closed.