A Short-Run Two-Sector Model with Immobile Capital

Abstract

STANDARD IS-LM ANALYSIS assumes a single homogeneous commodity that can be purchased at a unique price and either consumed or added to the capital stock. Although the realism of this assumption is seldom discussed, it can be motivated by the argument that the relative prices of commodities are fixed in the short run. One possible rationale for this is that prices are exogenous; another is that some group of consumers, producers, or hoarders views the different commodities as perfect substitutes. A third explanation is that labor and capital are mobile and inelastically supplied with all sectors having the same capital intensities for all wage-rental ratios. A fourth possibility is that if labor and capital are immobile and wages and pnces are flexible, then the equilibria of the separate labor markets will determine relative commodity prices independently of financial markets and the demand for commodities. The realism of these rationalizations is considerably less persuasive than the practical argument that the simplicity of the single commodity price model greatly enhances its expositional value. There is, unfortunately, ample evidence that relative prices do change (often dramatically) and only a limited literature on the distortions introduced into IS-LM models by the pretense that relative prices do not change. Most authors (such as [4, 8, 9]) who have distinguished between the prices of consumption and investment goods have followed the neoclassical tradition of treating capital as a perfectly mobile factor of production. Although this would seem to make them most relevant for long-run analysis, a short-run Keynesian flavor is sometimes provided by ie assumption that the nominal wage is fixed at a level such that the supply of labor exceeds the demand.