Abstract This paper applies our established analytic technique of the relative derivative, (dy/dx)(a/b), to a quantitative comparative static analysis of a macroeconomy as based on the IS-LM framework coupled with a production function of five factors, capital, labor, oil, coal, and solar energy, resulting in twelve linear equations containing the general equilibrium growth rates of twelve endogenous variables, which are the six pairs of the (price, quantity) for the above output and five inputs. We conduct several simulations by substituting economically sensible values into all the parameters with some alterations for mathematical comparison, and finally we conclude with a summary remark. Mathematics Subject Classification: 91B02, 26B10, 91B62, 91B64, 91B7

Gregory L Light

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Int. J. Contemp. Math. Sciences, Vol. 9, 2014, no. 7, 313 - 323
HIKARI Ltd, www.m-hikari.com
http://dx.doi.org/10.12988/ijcms.2014.4437
Quantitative Comparative Statics by Relative
Derivatives on IS-LM with Five Production Factors
Containing Multiple Energy Sources
Gregory L. Light
Department of Finance, Providence College
Providence, Rhode Island 02918 USA
Copyright c© 2014 Gregory L. Light. This is an open access article distributed under
the Creative Commons Attribution License, which permits unrestricted use, distribution,
and reproduction in any medium, provided the original work is properly cited.
Abstract
This paper applies our established analytic technique of the relative
derivative, (dy/dx)(a/b), to a quantitative comparative static analysis
of a macroeconomy as based on the IS-LM framework coupled with
a production function of five factors, capital, labor, oil, coal, and so-
lar energy, resulting in twelve linear equations containing the general
equilibrium growth rates of twelve endogenous variables, which are the
six pairs of the (price, quantity) for the above output and five inputs.
We conduct several simulations by substituting economically sensible
values into all the parameters with some alterations for mathematical
comparison, and finally we conclude with a summary remark.
Mathematics Subject Classification: 91B02, 26B10, 91B62, 91B64,
91B76
Keywords: Perturbation sensitivity, scale invariance, dimensionless elas-
ticities, factor substitution, energy substitutability
1 Introduction
This paper serves as an extension of our previous publication [8] in this Journal
which modeled the general equilibrium growth of a macroeconomy by an aug-
mented IS-LM framework involving a simultaneous market clearance in goods,
314 Gregory L. Light
money, labor, and raw materials. Here we decompose raw materials into ”oil,”
”coal,” and ”solar energy,” to represent respectively ”non-renewable but rel-
atively clean,” ”relatively abundant but polluting,” and ”inexhaustible and
clean” energies resources (for an extension of the IS-LM model to environ-
mental economics, see, e.g., [6]). Again built upon our established analytic
apparatus of the relative derivative fx :=
(
df/b
dx/a
)
, a, b > 0, f ∈ C1 (R, R),
our expanded model here will comprise of a system of twelve simultaneous
linear equations in twelve variables, namely: the general equilibrium growth
rates of the general price level P , the ”real” yearly gross domestic product
y (”real” meaning adjusted for inflation), the real interest rate r (defined as
1 + interest/principal), the real capital-stock employment K, the real wage
rate w, the labor employment L, the real price of oil vo, the employed quantity
of oil O, the real price of coal vc, the employed quantity of coal C, the real
price of solar energy vh, and the employed quantity of solar energy H . The
prescribed parameters therein will consist of two kinds: (1) the partial relative
derivatives as some of the coefficients of the above-said 12 variables, and (2)
any exogenous percentage changes that can happen in the 12 equations (i.e.,
the right-hand-side constants in Ax = y, A ∈ GL (R12, R12)).
Our motivation here is to address the energy issue that confounds the world
economy. Otherwise we seek to demonstrate once again the analytic facility of
our proposed relative derivatives (for the advantages of dimensionless analy-
sis, cf. [1, 2]); basically relative derivatives transform comparative statics from
qualitative to quantitative analyses (for the wide-spread use of comparative
static analyses using the regular derivatives ∂y/∂x in social sciences, cf., e.g.,
[3, 4, 5, 11]). In the next Section 2 we will first repeat all the pertinent essen-
tials from our previous paper so as to make the present one self-contained;
then we will simulate several comparative static results by varying certain in-
terested parameters. Since our added contribution from this paper is a detailed
breakdown of the previous production factor of raw materials, our simulations
here below will all be about the ”supply side” of an economy (for a general
perturbation analysis of the system with a policy orientation, cf. our paper
[7]). Finally in Section 3 we will conclude with a summary remark.
2 Analysis
2.1 The Model
Notation 1 Assuming that all the functions below are C1 and that the time
period is one year, we denote respectively a proportional change in a variable
u relative to a fixed constant uo and the partial relative derivative of u with
Quantitative comparative statics 315
respect to a variable x evaluated at (xo,uo) by
u̇ :=
du
dt
uo
, and ux :=
∂u
∂x
xo
uo
. (1)
Remark 1 We note that our relative derivative is a generalized elasticity in
the sense that the above (xo,uo) are fixed constants discretionarily chosen. As
such, we break free from the rigid setup of the known elasticity ux :=
∂ lnu
∂ ln x
(cf.
[10; 12: p. 126]).
Our first equation is to ensure an equal proportional change in the demand
power withdrawn from the economy s (y, r) and the demand power exerted
onto the economy i (r), i.e.,
s̃o + srṙ
 + syẏ = ı̃o + irṙ, (2)
where s̃o represents an exogenous percentage change in the sum of the real
private savings, government taxes, and the imports; analogously, ı̃o represents
an exogenous percentage change in the sum of the real private investments,
government expenditures, and the exports.
Our second equation relates proportional changes in i to that of K. Since i
minus the real depreciation δ equals dK
dt
as an identity, i contributes to capital
accumulation K through a modifying factor J as follows:
i̇ = K̇ + J , with (3)
J ≡
d
dt
(
dK
dt
+ δ
)
(
dK
dt
+ δ
) −
dK
dt
K
, (4)
where J will be simulated with a plausible value.
Our third equation is to ensure an equal proportional change in the real
money supplied M/p and the real money demanded l (y, r), i.e.,
Ṁ − Ṗ = lo + ly ẏ + lrṙ, (5)
where lo denotes an exogenous proportional change in the real money demand.
Our fourth equation is about the proportional change in y = f (K, L,O, C, H),
i.e.,
ẏ = ηKK̇
 + ηLL̇
 + ηOȮ
 + ηCĊ
 + ηHḢ
 + Ȧ, (6)
316 Gregory L. Light
where Ȧ denotes an overall technology growth rate.
Our fifth equation is to relate proportional changes in (K/L) to that
in (w/r), (vo/r), (vc/r), and (vh/r), observing the economic law of cost-
minimizing input demands to be homogeneous of degree zero in the input
prices,
K̇ = L̇ + σKLw ·
(
ẇ − ṙ) + σKLvo ·
(
v̇o − ṙ
)
+σKLvc ·
(
v̇c − ṙ
)
+ σKLvh ·
(
v̇h − ṙ
)
+ ko, (7)
where ko represents an exogenous proportional change in (K/L), reflecting a
shift in the production technology, favoring K if ko > 0 and favoring L if ko < 0
(for a restrictive study involving the above two equations, (6), (7), cf. [9]).
Analogously we have the following equations six, seven, and eight in our
linear system:
K̇ + oo = Ȯ + σKOw ·
(
ẇ − ṙ) + σKOvo ·
(
v̇o − ṙ
)
+σKOvc ·
(
v̇c − ṙ
)
+ σKOvh ·
(
v̇h − ṙ
)
, (8)
K̇ + co = Ċ + σKCw ·
(
ẇ − ṙ) + σKCvo ·
(
v̇o − ṙ
)
+σKCvc ·
(
v̇c − ṙ
)
+ σKCvh ·
(
v̇h − ṙ
)
, and (9)
K̇ + ho = Ḣ + σKHw ·
(
ẇ − ṙ) + σKHvo ·
(
v̇o − ṙ
)
+σKHvc ·
(
v̇c − ṙ
)
+ σKHvh ·
(
v̇h − ṙ
)
. (10)
Our ninth equation is about the supply of L,
L̇ = Lo + Lw ·
(
ẇ + αṖ
)
, (11)
where Lo represents an exogenous proportional change in the quantity of the
labor force, and α ∈ [0, 1] measures the degree of ”money illusion” in labor
supply; α = 0 means that labor supply is a function of the real wage rate w,
while α = 1 means that labor supply is a function of the nominal wage rate
wP .
Similarly we have the following supplies of O, C, and H as our equations
ten, eleven, and lastly twelve in our linear system,
Ȯ = Oilo + oilp · v̇o , (12)
Ċ = Coalo + coalp · v̇c , and (13)
Ḣ = Suno + sunp · v̇h , (14)
where Oilo, Coalo, and Suno represent exogenous proportional changes in their
supplies.
Quantitative comparative statics 317
2.2 Simulation
We begin with the following ”Basic Configuration” of the parameters, where
economically sensible values are substituted into all the parameters:
s̃o + srṙ
 + syẏ = ı̃o + irṙ = i̇ =
−1% + 0.5ṙ + ẏ = 1% − ṙ, (15)
i̇ = K̇ + J = K̇ + 1%, (16)
Ṁ − Ṗ = lo + lyẏ + lrṙ =
5% − Ṗ = ẏ − 0.5ṙ, (17)
ẏ = ηKK̇
 + ηLL̇
 + ηOȮ
 + ηCĊ
 + ηHḢ
 + Ȧ
= 0.4K̇ + 0.4L̇ + 0.09Ȯ + 0.009Ċ + 0.001Ḣ + 0.5%, (18)
K̇ = L̇ + σKLw ·
(
ẇ − ṙ) + σKLvo ·
(
v̇o − ṙ
)
+σKLvc ·
(
v̇c − ṙ
)
+ σKLvh ·
(
v̇h − ṙ
)
+ ko
= L̇ +
(
ẇ − ṙ) + 2%, (19)
K̇ + oo = Ȯ + σKOw ·
(
ẇ − ṙ) + σKOvo ·
(
v̇o − ṙ
)
+σKOvc ·
(
v̇c − ṙ
)
+ σKOvh ·
(
v̇h − ṙ
)
=
K̇ − 0.5% = Ȯ + 0.5 · (v̇o − ṙ
)
, (20)
K̇ + co = Ċ + σKCw ·
(
ẇ − ṙ) + σKCvo ·
(
v̇o − ṙ
)
+σKCvc ·
(
v̇c − ṙ
)
+ σKCvh ·
(
v̇h − ṙ
)
=
K̇ − 0.5% = Ċ + 0.5 · (v̇c − ṙ
)
, (21)
K̇ + ho = Ḣ + σKHw ·
(
ẇ − ṙ) + σKHvo ·
(
v̇o − ṙ
)
+σKHvc ·
(
v̇c − ṙ
)
+ σKHvh ·
(
v̇h − ṙ
)
=
K̇ + 0.5% = Ḣ + 0.5 · (v̇h − ṙ
)
, (22)
318 Gregory L. Light
L̇ = Lo + Lw ·
(
ẇ + αṖ
)
= 0.5% +
(
ẇ + 0.5Ṗ
)
, (23)
Ȯ = Oilo + oilp · v̇o
= 0.5% + 0.5v̇o , (24)
Ċ = Coalo + coalp · v̇c
= 0.5% + 0.5v̇c , (25)
and
Ḣ = Suno + sunp · v̇h
= 0.1% + v̇h . (26)
Based on the above Basic Configuration of parameters in the 12 equations,
we have the following solution:
Ṗ = 5.18%, ẏ = 0.16%;
ṙ = 0.67%, K̇ = −1.17%;
ẇ = −2.79%, L̇ = 0.29%;
v̇o = −0.84%, Ȯ = 0.08%;
v̇c = −0.84%, Ċ = 0.08%;
v̇h = −0.96%, Ḣ = −0.86%. (27)
We now alter the above Basic Configuration by a singular variation in the
exogenous supply of oil from Oilo = 0.5% to −1%; then the new solution
becomes:
Ṗ = 5.27%, ẏ = 0.08%;
ṙ = 0.71%, K̇ = −1.21%;
ẇ = −2.82%, L̇ = 0.32%;
v̇o = 0.65%, Ȯ
 = −0.68%;
v̇c = −0.85%, Ċ = 0.07%;
v̇h = −0.97%, Ḣ = −0.87%. (28)
Quantitative comparative statics 319
Consider now another singular variation in ko from 2% in the Basic Config-
uration to 4%, indicating a technological shift to more capital using (or labor
saving); then the new solution becomes:
Ṗ = 5.73%, ẏ = −0.28%;
ṙ = 0.89%, K̇ = −1.39%;
ẇ = −3.93%, L̇ = −0.57%;
v̇o = −0.95%, Ȯ = 0.03%;
v̇c = −0.95%, Ċ = 0.03%;
v̇h = −1.03%, Ḣ = −0.93%. (29)
Our third simulation will be about an ”oil crisis” through a composite
variation from the Basic Configuration: to alter oilp from 0.5 to 0 indicating
that the oil supply does not respond to its price any more, to alter σKOvo
from 0.5 to 0 indicating that capital machineries cannot substitute for oil any
more, and lastly Oilo from 0.5% to −1% indicating that there is an exogenous
decline in the supply of oil; then the new solution becomes:
Ṗ = 5.31%, ẏ = 0.05%;
ṙ = 0.72%, K̇ = −1.22%;
ẇ = −2.83%, L̇ = 0.33%;
v̇o = 27554, Ȯ
 = −1%;
v̇c = −0.86%, Ċ = 0.07%;
v̇h = −0.97%, Ḣ = −0.87%. (30)
Our last simulation will be a variation of the 4× 4 matrix of input mutual
substitutability as embedded in the four equations, (19), (20), (21), and (22),
for the cost-minimizing input demands, from the Basic Configuration
σ w vo vc vh
K/L 1 0 0 0
K/O 0 0.5 0 0
K/C 0 0 0.5 0
K/H 0 0 0 0.5
(31)
to the following more sensible matrix entries,
σ w vo vc vh
K/L 1 0.2 0.2 0.1
K/O 0.2 0.5 −0.2 −0.2
K/C 0.2 −0.2 0.5 −0.2
K/H 0.2 −0.2 −0.2 0.5
(32)
320 Gregory L. Light
where (input i/ input j) is more responsive to (price j/ price i) as shown by
the dominant diagonal entries. Otherwise, since the raw materials of oil, coal,
and solar energy substitute more for capital machineries than for labor, as their
prices increase, the demand for capital relative to labor increases, accounting
for the first row in the matrix (with less substitutability between capital and
solar energy, shown as σKLvh = 0.1). For the second row, labor substitutes
more for capital machineries than for oil, thus σKOw = 0.2; however, coal and
the solar energy substitute more for oil than for capital machineries, thus,
σKOvc = σKOvh = −0.2. The third and fourth rows follow the same argument.
Then the new solution becomes:
Ṗ = 4.99%, ẏ = 0.31%; (33)
ṙ = 0.59%, K̇ = −1.09%;
ẇ = −2.40%, L̇ = 0.59%;
v̇o = −0.77%, Ȯ = 0.12%;
v̇c = −0.77%, Ċ = 0.12%;
v̇h = −0.90%, Ḣ = −0.80%.
2.3 Discussion
Remark 2 The feature of ”non-renewable but relatively clean” for our gener-
ically termed ”oil” was reflected by setting oo = −0.5% to show an exoge-
nous shift in the production technology to substitute capital machineries for oil
(”making the machines more energy efficient”) and by setting Oilo = 0.5% to
show a continuing increase in the exogenous supply of oil.
Remark 3 The feature of ”relatively abundant but polluting” for our generi-
cally termed ”coal” was reflected by setting co = −0.5% to show an exogenous
shift in the production technology to substitute capital machineries for coal to
reduce its pollution to the environment and by setting Coalo = 0.5% to show a
continuing increase in the exogenous supply of oil due to its relative abundance.
Remark 4 The feature of ”inexhaustible and clean” for our generically termed
”solar energy” was reflected by setting ho = 0.5% to show an exogenous shift
in the production technology to substitute solar energy for capital machineries
(such as alternative architectural designs of buildings) and by setting Suno =
0.1% to show a continuing increase in the exogenous supply of solar energy
independent of its price vh.
Quantitative comparative statics 321
Remark 5 Our above simulation of an ”oil crisis” showed, rather surpris-
ingly, that other than a skyrocketing increase in the oil price, v̇o = 27554,
the economy continued to function smoothly. In fact, even mathematically our
linear system of equations suffered only a removable discontinuity, of the form
0
0
with a limiting value of v̇o equal to 27554, i.e.,
v̇o → 27554, as oilp → 0 and σKOvo → 0 at Oilo = −1%. (34)
Remark 6 The equation in our simulation of the production function of the
economy
ẏ = ηKK̇
 + ηLL̇
 + ηOȮ
 + ηCĊ
 + ηHḢ
 + Ȧ
= 0.4K̇ + 0.4L̇ + 0.09Ȯ + 0.009Ċ + 0.001Ḣ + 0.5%
had
ηK + ηL + ηO + ηC + ηH = 0.9 < 1, (35)
showing a decreasing return to scales, with 1−0.9 = 10% of the gross domestic
product y appearing as the excess profits due to the existence of some non-
replicable factors in the production process, i.e., ”quasi-rent.”
Remark 7 From standard economics one has, in equilibrium,
ηK : =
∂y
∂K
K
y
=
rK
y
, so that (36)
dηK
dt
ηK
≡ η̇K = ṙ + K̇ − ẏ, i.e., (37)
dηK
dt
= F1 (ηK , ηL, ηO, ηC , ηH) . (38)
Similarly one has
dηL
dt
= F2 (ηK , ηL, ηO, ηC , ηH) , (39)
dηO
dt
= F3 (ηK , ηL, ηO, ηC , ηH) , (40)
dηC
dt
= F4 (ηK , ηL, ηO, ηC , ηH) , and (41)
dηH
dt
= F5 (ηK , ηL, ηO, ηC , ηH) . (42)
In our above Basic Configuration we had
η̇K = ṙ
 + K̇ − ẏ = 0.67% − 1.17% − 0.16% = −0.66%,
η̇L = ẇ
 + L̇ − ẏ = −2.79% + 0.29% − 0.16% = −2.66%,
η̇O = v̇

o + Ȯ
 − ẏ = −0.84% + 0.08% − 0.16% = −0.91%,
η̇C = v̇

c + Ċ
 − ẏ = −0.84% + 0.08% − 0.16% = −0.91%, and
η̇H = v̇

h + Ḣ
 − ẏ = −0.96% − 0.86% − 0.16% = −1.97%,
322 Gregory L. Light
so that the income distribution over the five production factors was not in equi-
librium (suggesting incidentally a deterministic cause for the phenomenon of
business cycles). Whether the above Fj (ηK , ηL, ηO, ηC , ηH) = 0, j = 1, 2, .., 5,
in Equations (38), (39), (40), (41), and (42), have positive solutions for ηK,
ηL, ηO, ηC, and ηH with an asymptotically stable general equilibrium depends
clearly on the parameters.
3 Summary Remark
From our above simulation, we see that the key to a global economic prosperity
lies in the existence of abundant supplies of environment-friendly energies along
with an overall technological growth, which falls in the domain of physical
sciences, in particular, chemistry. Otherwise, we have once again demonstrated
the utility of our proposed analytical tool of the relative derivative. To be sure,
one can easily extend the production inputs beyond the five factors as included
in the model of this paper.
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Received: April 25, 2014


Quantitative Comparative Statics by Relative Derivatives on IS-LM with Five Production Factors Containing Multiple Energy Sources

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Quantitative Comparative Statics by Relative Derivatives on IS-LM with Five Production Factors Containing Multiple Energy Sources

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