Sharp breaks and gradual transitions in markets:aggregate demand, aggregate supply and falling prices

My daughter and I had a discussion about isocline functions today at lunch. An unusual topic for lunch but a topic of increasing interest in neuroscience, chaos theory and other areas which seek to model dynamic shifts in functions. Look for example at the current oil price markets and the foreign exchanges based upon them. They have sharply changed from steady rising prices to a sudden plunge in prices that has recovered slightly but still might fall further. The same sort of behavioural modeling might well be applicable in the realm of accelerating growth and the impact upon output as opposed to prices. For the time being most prices are not rising because the slack in the economy is still too large. But at some point there will be a sharp shift and the vector forces that now affect output and to a much lesser extent prices, will shift to largely affect prices and much less so output.

Policy makers at the Fed and other central banks will want to know when that point is likely to happen and indeed would prefer to be able to accurately anticipate that point. To come up with the appropriate algorithm one needs to take into account both aggregate demand and aggregate supply and how they interact when the supply function is signaling falling prices but the demand function growing demand.

The presence of a cartel complicates the calculation. In this case the complication is large since the officials responsible for output decisions in the cartel who represent the largest supplier in the cartel are stating that they will not not cut output no matter how far prices will fall all the way down to $20 a barrel.

In the past I suggested in my papers on the natural rate of inflation versus the natural rate of unemployment that after the economy had suffered an anti inflation shock induced by policy or by events like the crash of 2008 it takes a long period of time for that impact to dissipate. The natural rate of inflation you will recall was that rate of inflation below which there is accelerating unemployment the exact opposite of the natural rate of unemployment.It will be interesting to see if this oil price collapse follows a similar trajectory.

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About haroldchorneyeconomist

I am Professor of political economy at Concordia university in Montréal, Québec, Canada. I received my B.A.Hons (econ.&poli sci) from the University of Manitoba. I also completed my M.A. degree in economics there. Went on to spend two years at the London School of Economics as a Ph.D. student in economics and then completed my Ph.D. in political economy at the University of Toronto. Was named a John W.Dafoe fellow, a CMHC fellow and a Canada Council fellow. I also was named a Woodrow Wilson fellow in 1968 after completing my first class honours undergraduate degree. Worked as an economist in the area of education, labour economics and as the senior economist with the Manitoba Housing and Renewal Corporation for the Government of Manitoba from 1972 to 1978. I also have worked as an economic consultant for MDT socio-economic consultants and have been consulted on urban planning, health policy, linguistic duality and public sector finance questions by the governments of Manitoba, Saskatchewan,the cities of Regina and Saskatoon, Ontario and the Federal government of Canada. I have also been consulted by senior leaders of the British Labour party, MPs from the Progressive Conservative party, the Liberal party and the New Democrats on economic policy questions. Members of the Government of France under the Presidency of Francois Mitterand discussed my work on public sector deficits. I have also run for elected office at the municipal level. I first began to write about quantitative easing as a useful policy option during the early 1980s.
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