**2**

IS^ respectively. In other words, with p unchanged, the decline in the volume of farm production would have unambiguously lowered farm incomes, leading to a decline in farm consumption and investment expenditure, and in consumption expenditure by non-farm households in

NF 2

receipt of y . This would have shifted IS_ to the left from IS ,

**r ** **Z ** **Z**

resulting in a fall in the demand for, and hence production of, non- traded goods, pushing IS^ to the left from IS , and so on. Further,

**and w were f ixed), there would be no changes in the relative price of**
**farn and norn-farm commodities to contend with, and no changes in the**
**real money stock.**

**As will become evident, this unambiguous leftward movement of**

3

**from ISy , which would have occurred in the Model I framework,**
**provides us with an important focal point for the present analysis.**

Returning to Model II , it is clear, from Figure IV(7), that,

assuming Y to be the scale argument, the leftward movement of IS^

2 3 2 3

from IS^ to IS^ would reduce r from r to r , so that Y falls from

2 3 2 3

Y to Y and Z moves from Z to Z .

We now need to solve three problems:

(1) we need to find a new market clearing price for farm output in the presence of the lower level of 0 ;

F

(2) we need to assess the net impact of the change in 0 , p and

**r ** **r**

J on f a r m income, and hence on expenditure originating from the farm sector;

(3) we need to assess the impact of the change in p , and the

**r**

change in expenditure originating from the farm sector, on the state of the Keynesian equilibrium in the non-traded goods sector..

Problem 1.

Suppose that the decline in the volume of farm production(ie .

the leftward movement of IS^ from I S ^ to IS^^O does mot induce any change in expenditure originating in the farm sector. [This assumption can be relaxed after problem (2) above is solved.] In other words,

2

we will assume that, despite the leftward movement of IS^ from IS^

3 2

to IS^ > IS^ remains at IS^, .

It is c lear that, given p ^ , and the original level of p^,

0 2

sa/ p , each volume of expenditure along IS can be converted to

F *L*

i s t h e n s i m p l y t h e p r o b l e m o f f i n d i n g a l e v e l o f p s u c h t h a t t h e
**r**
f a r m commodit y m a r k e t c l e a r s , i n t h e p r e s e n c e o f a g i v e n l e v e l o f
n o m i n a l e x p e n d i t u r e , z ^ .
F i g u r e I V ( 8 )
S e c t o r 1 1 ( 1 )

### z

a/F I n S e c t o r 1 1 ( 1 ) , t h e b u d g e t l i n e i m p l i e d by z a n d p i s**3**

**r**r e p r e s e n t e d by t h e l i n e w i t h i n t e r c e p t s Z3 z 3

**P**

**P U**f NF f F

The i m p l i e d vol ume o f e x p e n d i t u r e on f a r m c o m m o d i t i e s i s Z_ = 0_^ - 0

3 F F
i . e . j u s t s u f f i c i e n t t o c l e a r t h e f a r m commodit y m a r k e t . M a i n t a i n i n g
t h e l e v e l o f n o m i n a l e x p e n d i t u r e a t z ^ , i t i s c l e a r t h a t , f o l l o w i n g t h e
f a l l i n f a r m o u t p u t f r o m 0 ^ t o 0 \ a r i s e i n t h e p r i c e o f f a r m
**r ** **r**
c o m m o d i t i e s , f r o m p ^ t o p ^ wo ul d r e s u l t i n a f a l l i n t h e vol ume o f
**r ** **r**
3 4 1
e x p e n d i t u r e on f a r m c o m m o d i t i e s f r o m Z t o Z . H e nc e , p „ i s
**r ** **r ** **F**
c o n s i s t e n t w i t h c l e a r a n c e o f t h e f a r m c ommod it y m a r k e t a s 0^ f a l l s .
Two p o i n t s s h o u l d b e n o t e d . F i r s t l y , t h e new e x p e n d i t u r e p o i n t ,

4 4 0

Z Z , when valued at the original prices, p and p , is less

r Nr Nr r

3 3

than the original volume of expenditure Z^ Z ^ . In other words, a line drawn through the new expenditure point, and running parallel to the original budget line - line aa in Figure IV(8) - lies entirely inside the original budget line. It is also clear that, using p \

F

we could calculate a new volume of expenditure associated with each

2

other level of nominal expenditure along IS^ in Figure IV(7), and, in each case, the new volume of expenditure would be less than that

2

implied by IS . In other words, on the assumption that nominal

Zj

2

expenditure remains at the levels implied by points along IS^ , the

2

IS7 curve would move to the left from IS as p rises.

^ Z r

The second point to note is that the impact of the rise in p

r

from p ^ to p * on Z i s ambiguous. As drawn in Figure IV(8),

r r Nr

4 3

Z > Z . I n other words, the demand for farm commodites is price

NF NF

elastic, so that the fall in the volume of farm production is associated with a reduced level of nominal expenditure on farm commodities, and

increased nominal (and hence real) expenditure on non-farm commodities. However, if the demand for farm commodities was price inelastic, the converse conclusion would hold, i.e. nominal expenditure on farm commodities would rise, and nominal (and hence real) expenditure on non-farm commodities would fall.

Before proceeding to examine problems (2) and (3), it is useful to briefly review our analysis of problem (1) in terms of Sector 1.

Figure IV(9)

Sector I

It will be recalled that ISy 2 and IS *** represent the positions

of the IS curves in the new Keynesian equilibrium following the fall in J. The horizontal distance between ISy 2 and ISy 3 is the decline in the volume of farm output, measured at given prices. On the assumption that nominal expenditure originating from farm households was unchanged in the face of the decline in farm output, ^ would remain at IS 2 , given pF°. However, the rise in Pp from Pp° to p / reduced the Llurne of expenditure associated with any given level of nominal expenditure, so that IS moved from IS ^ to IS ^

z Z Z

The rise in pp would also clearly shift the LM curve to the left from LM°. However, the ambiguity surrounding the scale argument in the demand for money function leads to some ambiguity as to the extent of that leftward movement. Suppose that Z was the real scale argument

and that (not implausibly) the price and real expenditure elasticities of the demand for nominal money balances were both unity. In that

3 2

horizontal distance as the distance between IS and IS - because,

*L t*

3 2

by definition, horizontally opposing points on IS^ and IS^ are

associated with the same level of nominal expenditure. However, there 3 is no necessary presumption that horizontally opposing points on IS^

2

and IS^ would be associated with the same nominal value of income and hence with the same demand for nominal money balances in the case

where Y was the real scale argument.

In general then, we can conclude that LM would move to the left

from L M ^ , but the extent of that movement is unclear. Suppose that the LM curve moved from LM^ to LM^, with Y the real scale argument. It is clear that some upward pressure would be placed on the interest

3 4

rate relative to r , with a consequent lowering of Z below Z . It

will be assumed for simplicity, however, that this has only a negligible impact on the market clearing price for farm commodities, i.e. p

remains at pn1 Problems 2 and 3.

The next step is to assess whether there would be any further

3 3

movement in the IS curves from their positions at IS^ and IS^ . For our purposes, there are two potential sources of such a movement, as intimated by problems (2) and (3):

- a change in the level of expenditure originating from farm households, or from non-farm households in receipt of

NF

y or quota profits. This would violate the assumption r

2 of a given level of nominal expenditure, on which IS^

3

and IS^ are based;

2 2

- while ISy and IS^ are consistent with Keynesian

equilibrium in the non-traded goods sector (by assumption,

3 3

as noted above), ISY and IS may not be. It will be recalled that the levels of production of non-traded goods

2 3

2 3

equivalent - in other words ISV - IS = A Y .

**I ** **Y ** **F**

Therefore, if the demand for non-traded goods, at

2 3

horizontally opposing points on IS^ and IS^ are not

3 3

equivalent, then IS^ and IS^ would not be consistent wit h a Keynesian equilibrium in the non-traded goods

s e c t o r .

It is evident that the resolution of both issues lies in the own price elasticity of demand for farm commodities on the domestic market. Suppose that, in Figure IV(8), the own price elasticity of demand for farm commodities, across the arc between p ^ and p ^ had

**F ** **r**

been unity. It would follow that:

(a) the nominal value of farm sales on the domestic market would be unchanged, and farm receipts from a constrained volume of export sales (if any) would increase. As J has declined, it follows

F NF

that y and hence y and y have incresed. However, with a

r F F

higher level of p , profits accruing to holders of farm export

**r**

quotas would be lower. Therefore, the net impact of the change in farm output and farm prices on aggregate nominal expenditure is ambiguous. If the net effect was an increase, there would be

3

a tendency for IS^ to move to the right from IS^. , and conversely- in each case, setting in train a demand multiplier process in the non-traded goods sector ;

2 3

(b) at horizontally opposing points on ISZ~ and ISZ , the demand for non-farm, and hence non-traded goods, would be equivalent.

Therefore, IS^ would remain at IS^' whilever ISZ remained at

>Z *

Combining (a) and (b) above, therefore, we can conclude that, following the change in farm prices from p ^ to p \ the IS curves may

**r ** **r**

3

move either to the left or to the right of their positions at IS^

3

emerged from Model 1 where it was unambiguous that IS^ and IS^

3 2

would move to the left from IS^ and IS^ .

Next, consider the case where the demand for farm commodities is price elastic across the arc between p ^ and p ^. In particular,

**r ** **r**

**suppose that the price elasticity is -(1 + A) such that the gross**

value of farm production falls sufficiently to offset the decline in

F NF

the u s a g e of J, so that y , and hence y and y remain unchanged.

**F ** **F ** **r**

T h e n ,

(a) our assumption that farm consumption and investment expenditure, and consumption expenditure by non-farm households in receipt of

NF

y , remain unchanged would be valid. However, the rise in p

**r****r**

would reduce the level of profits accruing to holders of farm export quotas so that, on balance, aggregate expenditure would

2 decline relative to the level assumed in the location of IS„ and hence IS, In other words, there would be a tendency for IS to move to the left from IS , thus reducing aggregate demand

*Lt * *L»*

for non-farm and hence non-traded goods; 3

(b) at each point on IS^ , the demand for non-farm, and hence non- traded, goods is greater than at the horizontally opposing point

2 3 3

on IS . In other words, IS and IS would be associated with

*Li * *Lt* JL

excess demand for non-traded goods. With other factors unchanged, production of non-traded goods would increase, pushing IS^ to the

3

right from IS^ » and setting in train a positive demand multiplier process in the non-traded goods sector.

Combining points (a) and (b) above, it follows that the direction

3

of movement of IS^ from IS^ is ambiguous. If the leftward movement

3

of IS^ from ISZ is insufficient to eliminate the excess demand for

3 3

non-traded goods which exists at IS^ and IS^ , then IS^ would move to

f 3

the right from IS^ as production of non-traded goods increases. This would, in turn, set in train a positive demand multiplier process in

the non-traded goods sector, pushing IS further to the right, and instigating a rightward movement of IS • Conversely, if the

3

leftward movement of IZ from IS is sufficient to more than eliminate

Z Z

3 3

the excess demand for non-traded goods evident at IS and IS , then

1 Zj

production of non-traded goods will fall, pushing IS to the left from

3

IS^ . A negative Keynesian demand process would then push both IS^ and IS further to the left.

As might be anticipated, the case where the own price elasticity of demand for farm commodities lies between -1 and -(1 + X) shares elements in common with the two preceding cases, ie. where the elasticity was -1, and where it was -(1 + X). in this case, the

gross value of farm production either rises, or falls insufficiently

F NF

to offset the decline in J , so that y , and hence y and y rise.

r r r

However, quota profits fall. Therefore:

(a) as was the case with a unit elasticity, aggregate expenditure
**2**

may rise or fall relative to the level on which IS^, and

3

IS are based, i.e. the IS curve may move to the right or

*La* *La*

3

to the left from IS^ ;

3 3

(b) as was the case with an elasticity of -(1 + X)} XS^ and IS^ would be associated with an excess demand for non-traded goods and hence, with other factors unchanged, there would be a

3

tendency for IS^ and IS^ to move to the right from IS^ and

3

IS in a positive Keynesian demand multiplier process. Therefore, there is again a substantial degree of ambiguity as to the direction of movement of ISY fromISY . If, in (a) above,

3

the IS curve moved to the right from IS^ , that would reinforce the

3 3

excess demand for non-traded goods evident at IS^ and IS^ , leading

3 3

to a cumulative rightward movement of IS^ and IS^ from IS^ and IS^. .

3

However, if in (a), IS moved to the left from IS , then the nature

*La* *L*

case where the own price elasticity of demand was assumed to be - (1 + X). In other words, if some excess demand for non-traded goods remained, following the leftward movement of IS^ from IS^ ,

3

then IS^ would move to the right from IS^. , and the leftward movement of IS^ would be reversed. Alternatively, if a situation of excess supply had been created in the non-traded goods sector, then IS

Y would have moved to the left from IS^ , and the leftward movement

of IS^ would have been reinforced.

Next, we can consider the case where the own price elasticity

of demand for farm commodities is greater than (ie. more elastic than) -(1 + X). In this case, the decline in the gross value of farm

production is more than sufficient to offset the decline in the u s a g e NF

of J, so that y , and hence y and y fall. There is also, of

**r ** **F ** **F**

course, a decline in quota profits. It follows that:

(a) consumption and investment expenditure by farm households, and consumption expenditure by non-farm households in receipt of

NF

y and quota profits, would fall. In this case, therefore,
**r**

it is unambiguous that, with other factors unchanged, IS^ would

3

move to the left from IS v ;

(b) with the own price elasticity of demand being in excess of