Sonic Learns Remedial Econ #1: Aggregate Demand
April 17, 2011 4 Comments
It’s starting to become apparent that perhaps I should try to learn some Economics. Despite my ersatz profession, in which I deal with economic concepts and indeed engage in economics daily, I can’t say that I actually ever studied much of it formally, beyond hazy memories of supply-demand curves on a chalkboard, some quick cramming of finance textbooks before my first quant phone screening interview, and perhaps a couple of abortive, ill-conceived attempts to play TradeWars in college.
This makes me feel as though I’m at a slight disadvantage when reading things such as the Mark Thoma post referenced below, or (say) Matthew Yglesias when he snidely complains of a post-budget-deal consensus view that
…“everyone agrees” that it makes sense to reduce aggregate demand in the middle of a recession.
You see, when I read such things, my every instinct, training, experience, my every ounce of intelligence tells me that I am reading meaningless goddledygook by people trying to punch above their intellectual weight. It’s not that I think Matthew Yglesias is wrong, exactly, so much as that he is throwing around words he was taught that do not have objective meaning, but which are nevertheless regularly used together, by the initiated (Keynesians, or whatever), in certain closed-circle constructions (i.e. ‘you should increase Aggregate Demand during a Recession’) that as far as I can see have the form and function of catechism, or prayers.
However, I can’t prove that these guys are speaking the nonsense that my brain tells me they are, because I simply didn’t sit through whatever undergraduate Economics classes these guys clearly took and are basing their feigned Economics expertise on. So what I’m going to do is to try to learn some. On the Internet.
The way I envision this working is that I do a little lazy reading, presumably on wiki, and I try to restate what I think I’ve learned. This will be similar to my teaching days – cram before the lecture, then give the lecture. (There is nothing like teaching a subject for helping you actually learn it. Do you think I really understood why the Mean Value Theorem was true before I taught calculus, or how to derive the (4,5) Runge-Kutta Method before teaching Numerical Methods?) In other words, I’m going to ‘teach’ my readers the Economics I can hastily crib. I’ll state Economics facts as I understand them. I’ll ask questions about the things I don’t understand. Then if/when I’m wrong about something, hopefully people will show up in comments to tell me what a moron I am, because it’s really like so. So haha, in this fashion I will learn by subterfuge.
I’m kind of excited about this new half-assed project I just made up, so let’s get started before I drop it. I can think of no better place to start than with this aggregate demand thing all the hip Keynesians like to talk about.
In macroeconomics, aggregate demand (AD) is the total demand for final goods and services in the economy (Y) at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. This is the demand for the gross domestic product of a country when inventory levels are static.
Right away we’re off to a rip-roaring start because wiki appears to have three, somewhat conflicting definitions of this (obviously important in the Keynesian pantheon) term. First, there is the total demand for ‘final’ goods and services (whatever that means) at a given time & price level. But it’s also the amount ‘that will be purchased’ at ‘all possible price levels’ (?). Which is it, demand at a given price or at ‘all possible’ prices? Let’s just assume you can have a continuum or family of aggregate demands, one for each specification of prices. Meanwhile, the third sentence gives a qualifier – ‘when inventory levels are static’ – that as far as I can tell never obtains in the real world. Ah, I just love 19th century style, quasi-thermodynamics-style scientific thinking.
Anyhow, one way or another, there are two immediate take-aways I have about aggregate demand: (1) you have to designate it with letters ‘AD’ because using letters for things = science, and (2) the idea is to capture how much stuff will be, or is, bought, overall.
Some questions I have right away:
1) What is stuff? The first definition above alludes to this problem by trying to get away with speaking about ‘final’ goods and services. What is ‘final’? Can this be defined? If I buy a widget, that’s a ‘final’ purchase, but what if a business buys a widget that is used to make a whatsit, is that ‘final’ or is the whatsit ‘final’? Which services are ‘final’ and which are intermediate? Appears to me a large chunk of our economy nowadays consists of one sort of ‘intermediate’ transaction or another.
2) This may be unimportant at this stage but I feel the need to aside that every purchase is an exchange, and every ‘demand’ is really two-sided. You might think that when I buy milk that I demanded the milk at the price that milk had on its price tag, but it’s equally-correct to say that the milk seller had a demand for cash, and I was offering a certain amount of cash for a ‘price’ of 1 gallon of milk. I want to be on the watch for these terms introducing an artificial distinction between the two sides of this transaction.
Anyway, let’s proceed to how AD seems to be used:
The aggregate demand is usually described as a linear sum of four separable demand sources.
AD = C + I + G + (X-M)
Ah lovely. Define a concept and then proceed to ‘define’ it as some formula as if the formula automatically follows from the definition. A more appropriate way to describe this is as an attempt to partition AD into a small number of (presumably known/measurable) sources.
Anyway, we are told that C = ‘consumption’ or consumer spending, I = ‘investment’ (whatever that is!), G = government spending, and (X-M) = exports – imports = net export. So if I’m going to break it down in plain language, when stuff our economy makes is bought, it can either be bought by us of our own volition (as consumers; that’s C); by our government using force of law after having picked our pockets via taxes and/or printed money (that’s G); or by foreigners (that’s X-M).
Now we hit a snag because what is I? AD is supposed to be, loosely speaking, ‘all stuff demanded’. I is supposed to be ‘investment’. If I’m to believe that AD = C+G+I+(X-M), it appears to me that this can only really be a definition of investment: all stuff demanded that is not consumer spending, government spending, or foreign exports. If I later find out that investment (I) has an independent definition, I’m going to call foul.
The other snag is that wiki says those sources are ‘separable’, but that doesn’t really mean anything non-symbolic; i.e. sure we can ‘separate’ the quantity AD into these other quantities C, I, G etc., but what does that mean? Are they independent quantitites? I think not. Surely C depends on G, I, X, M, and surely M depends on C, I, G, X, and on and on. All of these quantities are interrelated and influence each other; attempts to ‘separate’ quantities that are not actually independent being another thing I feel like I have to be on watch for.
Anyhow, so this takes us to Matthew Yglesias’s complaint: that the government (in reducing the budget) ‘reduced aggregate demand’. We see that there’s no way he can possibly know this unless what he means to say is that the government reduced G, and since AD = G + (stuff), since G nominally will go down, that automatically reduces aggregate demand.
If that’s what he meant, then, we have now learned that he was indeed just wrong. Because in fact, AD = G + (other stuff that could and does depend on G too), and we don’t know whether reducing G actually will reduce that other stuff. Maybe it will, maybe it won’t, but the one thing we can be sure of with 99 94/100% confidence is that Matthew Yglesias has no idea what the actual effect of the budget deal on ‘aggregate demand’ will be. He simply did not do any real reasoning or computation about the true effect of the budget deal AD, and most likely, is not capable of doing so.
A natural next question is, why does it even matter whether AD has or will go up or down? What is Matthew’s real concern? But that will have to wait till another time,
End of Remedial Econ #1.