Aggregate Supply - Effective Demand model updated for 4Q-2013

Here is the updated graph of the AS-ED model (aggregate supply-effective demand).

The blue dots show real GDP increasing to the right over the past 8 quarters. The downsloping lines of the effective demand limit have stayed within a fairly tight band. There are two lines that fell out of that band. One was the labor income surge at the end of 2012. The other was the capital income surge at the end of 2013. The effective demand limit corrected back to the band after the labor income surge of 2012. I expect the effective demand limit to correct back to the band in 2014.

Real GDP surpassed the effective demand limit in the 4thQ-2013 (blue dot is above red dot). However, the band determines the zone of the effective demand limit. Thus, real GDP is just now reaching the zone of the effective demand limit. According to the past history of data for the effective demand limit, we would now start to see real GDP slow down and/or move vertical (up or down). An increase in the inflation rate is common from the past data. However, there may be a deflationary reaction as over-production in the face of weaker demand meets lower utilization of labor and capital.

Comments

[Jim Hornsby]

This graph with some added data is a part of your post on the ABblog. Jack has pointed out that it is confusing to some.

I confess that it took me a minute or two to the find Real GDP blue dots and Effective Demand lines and then ignore the rest. (I was impatient and skipped straight to the graph!) But the truth is that everything in that graph is important except for the Aggregate Supply plot lines. And I assume that the AS lines would be more important to me if I needed a more complete view of the interactions in the economy.

Below your graph is this paragraph:
"The blue dots show real GDP increasing to the right over the past 8 quarters.The up-sloping lines are aggregate supply for real GDP for the given inflation rate. The down-sloping lines are effective demand. The down-sloping lines of the effective demand limit have stayed within a fairly tight band. Effective demand has fallen into this band 6 of the past 8 quarters."

Perhaps you should include in this paragraph, a link to your best explanation of effective demand on your website. That would seem to be preferable, to dumbing down your graph.

Frankly my understanding of Effective Demand came because of your early formulas, so I do not know how you would explain it without them. I suppose you will need a very good explanation of each variable and an emphasis on the direct or inverse relationships.

The explanation of the 2012 and 2013 Effective Demand plot line deviations is encouraging. Variation is troubling, if there is no explanation.

[Edward Lambert]

Jim,
It is tough to have to explain effective demand every post. I suppose I have to do it.