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It was Keynes who led vigorous and systematic attack on … Classical theory of employment is based on ‘ Law of market’ which states that ‘supply creates its own demand’. Watch Queue Queue. -­‐ The price of the good – in this case 1/ – appears on the vertical axis.P -­‐ The money demand curve slopes downward. They regarded unemployment as a temporary phenomenon and assumed that there is always a tendency towards full employment. • Examines likely impact of the potential factors that influence its demand. In doing so he distinguishes between different uses for money; as an asset and as a factor of production, by considering separately the demand for money of ultimate wealth holders and of business enterprises. Lecture Note on Classical Macroeconomic Theory Econ 135 - Prof. Bohn This course will examine the linkages between interest rates, money, output, and inflation in more detail than Mishkin’s book. The relationship between the supply of money and inflation, as well as deflation, is an important concept in economics.The quantity theory of money is a concept that can explain this connection, stating that there is a direct relationship between the supply of money in an economy and the price level of products sold. The theory predicts that a person who earns $200 a week will, on average, carry half as much cash and will keep half the balances in his checking account than a person who earns $400 dollars a week. 3. 3 1. KEYNESIAN THEORY OF EMPLOYMENT J.M. This implies that supply creates a matching demand for it with the result that the whole of output is sold out. Indeed, it seems likely that wealth would also roughly double in nominal terms over a decade in which nominal income had doubled. It is determined by the demand for and supply of money. Keynes "The General Theory of employment, Interest and Money" published in 1936. The classical theory of employment states that in a labor market, employment for labors is determined by the interaction between demand and supply of labor, where the workers provide a constant supply of labor, while the employer makes demand for them. Interest rates interact with output and inflation. According to Fisher, MV = PT. For new classical economists, following David Hume's famous essay "Of Money", money was not neutral in the short-run, so the quantity theory was assumed to hold only in the long-run. Where, M – The total money supply; V – The velocity of circulation of money. The way in which these factors affect money demand is usually explained in terms of the three motives for demanding money: the transactions, the precautionary, and the speculative motives. Classical Theory of Income and Employment: Aggregate Demand, Money and Prices: Now, we shall examine how full employment of labour is assured in the classical theory even when money is introduced in the system. It is important to notice that the demand for money in the classical theory is the relationship between a stock (money on hand) and a flow (weekly purchases of commodities). View CLASSICAL THEORY OF DEMAND FOR MONEY.pdf from ECON 805 at Nairobi Institute of Technology - Westlands. LIQUIDITY PREFERENCE THEORY The cash money is called liquidity and the liking of the people for cash money is called liquidity preference. The price level is determined from the quantity theory of money: P = (M*V)/Y. The equation tells that the total money supply MV equals the total value of output PT in the economy. Classical theory is the basis for Monetarism, which only concentrates on managing the money supply, through monetary policy. demand for money holdings through the portfolio motive. Quantity Theory of Money. Classical Quantity Theory of Money Due to Irving Fisher (1911) Idea: to examine the link between total money supply Msand the total amount of spending on final goods and services produced in a given period (PY). Watch Queue Queue With the inclusion of real as well as monetary factors, the loanable funds theory becomes superior to the classical theory. The supply of money is considered to be fixed in the short run by monetary authorities. It regards money as a flow since the supply of money is related to the period of time. Money Does not Matter. Figure considers a decrease in aggregate demand from AD 1 to AD 2. and Employment Postulates Always full employment. aggregate demand (Lord Keynes) had studied classical economics and wrote his famous General Theory of Employment, Interest and Money. According to him, the problems of the real world are related to the theory of shifting equilibrium whereas money enters as a “link between the present and future”. This 18th-century Englishman developed the basics of classic economics, asking and answering questions such as "What are the basic principles of capitalism?" The Classical economists, David Ricardo, Karl Marx and, to a lesser degree, John Stuart Mill disagreed with both the "pure" Quantity Theory of Hume and the real bills doctrine of Smith.They possessed what is known as a "commodity theory" or "metallic theory" of money. (This is an argument to reject austerity policies of the 2008-13 recession. Third, there is also the difference between the monetary mechanisms of Keynes and Friedman as to how changes in the quantity of money affect economic activity. The classical and the neoclassical economists almost neglected the problem of unemployment. Fisher’s theory explains the relationship between the money supply and price level. Graphical illustration of the classical theory as it relates to a decrease in aggregate demand. Assumptions Laissez faire Non Intervention of the Government Perfect Competition Market Mechanism Consumer and Producers freedom. 10. • Explores the relationship between price and demand for a product. Another weakness of the quantity theory of money is that it concentrates on the supply of money and assumes the demand for money to be constant. According to Keynes people demand liquidity or prefer liquidity because they have three different motives for holding cash rather than bonds etc. Back . Velocity of moneyaverage number of times per year that a dollar is spent in purchasing goods and services. Classical Theory of Output. They argued that money is not demanded for its own sake, that is, not for its store value. Money, in their view, was simply gold, silver and other precious metals. The theory is thus characterised as the monetary theory of interest. These theoretical considerations involved serious changes as to the scope of countercyclical economic policy. Introduction to Quantity Theory . Says Law French economist Jeane Baptiste Say Supply Creates its own demand. In this economy there cannot be over production … This also means that the average number of times a unit of money exchanges hands during a specific period of time. It is determined by the central bank (as discussed in the monetary base and the supply of money). Role of Money – The neo-classical theory took into consideration the importance of monetary factors, like cash, credit, hoardings, etc., while remaining essentially a classical saving- investment theory of interest. Smith's core idea was that players in the economy act out of self-interest and that this actually produces the best outcome for everyone. Essentially, Keynes’ theory of demand for money is an extension of the Cambridge cash-balances approach and stresses the asset role (i.e., the store of value function) of money. This video is unavailable. Classical Theory of Inflation A. Overall, the quantity of money demanded at any given interest rate will be much higher a decade later under our assumptions, probably about twice its level a decade earlier. The I Theory of Money Markus K. Brunnermeiery and Yuliy Sannikovz rst version: Oct. 10, 2010 this version: June 5, 2011 Abstract This paper provides a theory of money, whose value depends on the functioning of the intermediary sector, and a uni ed framework for analyzing the interaction between price and nancial stability. The demand for money is affected by several factors, including the level of income, interest rates, and inflation as well as uncertainty about the future. 3 Main Approaches to Demand for Money are described below: (A) Classical Approach to Demand for Money: The main exponents of this approach are J.S. Mill’s theory of reciprocal demand has been criticised on the following grounds: (i) The theory is based on unrealistic assumptions, such as perfect competition and full employment. (iii) Mill concentrates on the elasticity of demand, thus neglecting the impact of elasticity of supply. WHAT IS DEMAND? The classical quantity theory of money states that the price level is a function of the supply of money. The price level is affected only by that part of money which people hold in form of cash for transaction purpose and not by MV as suggested by the Classical theory. In the classical model, money supply M is an exogenous variable (hence, the growth rate in the money supply πM is exogenous). Further, Keynes criticises the classical theory of static equilibrium in which money is regarded as neutral and does not influence the economy’s real equilibrium relating to relative prices. Neglects Real Balance Effect: In order words, it neglects the store-of-value function of money and considers only the medium-of-exchange function of money. THEORY OF “DEMAND” 2. According to the neo-classical theory given by Marshall, Pigou, etc., money does not serve only as a medium of exchange but also as a store of value. Thus the theory is one-sided. 2. The classical theory is a real theory of interest and neglects monetary influences on interest. Mill, Irving Fisher, Marshall, Pigou and Robertson—all grouped as classical economists. Algebraically, MV=PT where M, V, P, and T are the supply of money, velocity of money, price level and the volume of transactions (or real total output). • Factors determining demand for a product. In the Keynesian theory, the demand for money as an asset is confined to just bonds where interest rates are the relevant cost of holding money. Instead, […] (which was a complete rebuttal of the classical theory) 30 Keynesian in a Nutshell 31 Keyness View of Says Lawin a Money Economy According to Keynes, a decrease in consumption While you have taken intermediate macro, most of Mishkin’s book is meant to be accessible to less prepared students. In this article we will discuss about the classical and Keynesian views on money. In his General Theory of Employment, Interest and Money (1936), J.M. Transaction Motive 2. So, there is no deficiency in aggregate demand and hence no possibility of over-production and unemployment. Keynesian economics suggests governments need to use fiscal policy, especially in a recession. Precaution Motive 3. The ... supply-­‐and-­‐demand theory to money: -­‐ The quantity of the good – in this case money – appears on the horizontal axis. The classical theory of economics exists because of Adam Smith. 1. In the State of Equilibrium. Classical economics places little emphasis on the use of fiscal policy to manage aggregate demand. Milton Friedman, at the forefront of the modern quantity theory, outlines a stable demand for money and its determinants. INTRODUCTION • How much to produce and what price to charge? Keynes expounded his theory of demand for money. THEORY OF DEMAND 1. (ii) Actual trade is not restricted to two country, two commodity model.

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