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An outline of the PAC Model functions

Hector McNeill1
SEEL



PACM analysis equates supply side activity payments of wages as income and the consumption resulting from that is governed by unit price movements and the purchasing power of the currency. This closed loop system is the supply side of the economy which relies of increases in savings and investments in productivity as the source of economic growth through more accessible production (supply) in terms of information, availability and unit prices and enhanced real incomes.

What is commonly referred to as "Demand" is stimulated by what is produced and unit prices and the price elasticity of consumption.

This system is self contained and growth does not require debt to grow. The rate of growth of the supply side model depends upon the Real Aggregate Growth Model (RAGM) which arises from the balance between incomes paid and unit prices. This is a lower risk pathway towards economic growth and it can substitute the Aggregate Demand Model that has had the result of increasing debt, rising income disparity, declining real incomes and deficient investment in productivity. The advantage of the RAGM is that it encourages governments and enterprises to focus on making a more effective use of the principle factors responsible for 80% of economic growth. These are the contribution of technology, techniques, learning and the acquisition of tacit and explicit knowledge and beneficial change arising from innovation.

An outline of the PAC Model functions

The PACM is a depiction of the supply side of an economy presented as a closed system.

There are four key cash flow links:

⊚ 1. Production pays wages and incomes

⊚ 2. The value of incomes are transformed into purchasing power according to the accessibility of output linked to logistics:

⊚  Output can be stored (inventory) and not immediately sold or kept as an asset

⊚  Products and services need to be deliverable to the place of use

⊚  Consumers need accessibility to information on products and services and their prices

⊚  Unit prices need to be accessible (affordable)


⊚ 3. Purchasing power or disposable real income can be divided into savings, asset holdings or consumption

⊚ 4. Some savings can be routed back through loans to investment


Important observations

  • In link 2. supply side cash flow and availability for consumption will fall by the amount of product placed in inventory as a reserve of assets for future sale

  • In link 3. the quantity of funds flowing into consumption and investment for production will decline if purchasing power (disposable income) is used for medium to long terms savings or asset purchases
Therefore falls in consumption can arise from unit price rises (inflation) that depress purchasing power of nominal incomes, accumulation of supply chain inventories as assets (hoarding) limiting supply, rises in savings (removed from consumption cash flow) and rises in asset holdings (removed from savings cash flow). Recent experience under Quantitative Easing (QE) has lowered interest rate to close to zero but increased exogenous money supply as low interest debt has been fed into assets resulting in a reduction in the volume of additional exogenous cash flow entering the transactional supply side activities.

The relevant Quantity Theory of Money that explains this distortion is the Cambridge Equation modified and nominated as "Real Theory of Money" (RTM) is shown below

M = (a + k) . P. Y ..... (iv)
Where:

M is the quantity of money; P is the price level; Y real income. a is assets; and k is savings.

By bringing a and k to the left hand side as the divisor of M the strong depressive impact of rising asset holdings on the availability of money so as to reduce P.Y is evident:

M
(a+k)
=P . Y ..... (v)


This explains how the exogenous funds that were not generated by the supply side have intruded so as to deny the supply side of funds for investment while channeling the exogenous funds into assets that would normally remain within the purchasing power of the supply side. However rather than see economic growth, in spite of close to zero interest rates, this has resulted in lower real incomes, lower substanative investment and deficient growth in productivity. As is self-evident, the rise in exogenous money did not have any practical impact on "aggregate demand"."

Without this intervention, incentives applied to the logistics elements of accessibility to products, information and unit prices facilitated a real income policy making use of the price performance ratio and price performance levey would have guided investment towards higher productivity and based on the endogenous supply side money cash flow achieve real growth in real consumption. This explains the basis operation of the Real Aggregate Growth Model (RAGM).


1 Hector McNeill is the Director of SEEL-Systems Engineering Economics Lab.