Read: Variables For An Effective Demand Limit To The Business Cycle Part 1

 Read: New Variable For Effective Demand Limit Part 2

 Read: New Variable For Effective Demand Limit Part 3

For those who have read this series of posts, you have seen the evolution of an Effective Demand model. At the end of this post, you decide if the model is useful.

The last two variables added to the limit function are for government expenditures and investment. Here is the final equation.

Effective Demand limit function, L = 0.70*LS + 20*NX/rGDP + 20*G/rGDP + 20*I/rGDP – 110*CPIall + 78*(ED-FF) – 75*(yoyC,10year-FF)

LS = labor share index (non-farm business sector), 2009 base year
NX = real net exports
rGDP = real GDP
G = real Government consumption expenditures and gross investment
I = real Gross private domestic investment
CPIall = year over year % change of CPI for all items.
ED = policy rate prescribed by Effective Demand Monetary rule after non-monetary variables have been set.
FF = Fed Funds rate
10year = 10-year Treasury Constant maturity rate

The equation has variables for domestic consumption power (LS), foreign consumption power (NX/rGDP), government consumption (G/rGDP), private investment (I/rGDP), inflation (CPIall) and monetary policy (ED, FF & 10year treasury). All these variables impact demand.

I gave NX, G and I the same coefficient (20) for parity in the equation. The other coefficients were designed to give a consistent limit. I explain this below.

I have put all these variables into an equation for effective demand… NOT AGGREGATE DEMAND, which is always equal to real GDP. Effective demand is the limit upon the utilization of labor and capital for production… and is by definition only equal to real GDP near the natural limit of real GDP.

So here is the graph of the equation above. The orange line is the effective demand limit function that marks the peaks of the TFUR business cycle (blue line). (TFUR = (capacity utilization * (1 – unemployment rate).