Jhingan-Macro-ajk$2.47#3 1,19656,1092,eco,eng,20150514,20150728,4,M.L. Jhingan: Macroeconomic Theory ama,https://www.amazon.com/Macro-Economic-Theory-M-L-Jhingan-ebook/dp/B00IKDI600/ref=cm_rdp_product_img eng,https://www.amazon.com/gp/review/R6YD7IX5599UH?ref_=glimp_1rv_cl 1,w,1,,Jhingan: Macroeconomic Theory 7,h,MACROECONOMIC THEORY 12TH REVISED AND ENLARGED EDITION 8,h,M.L. JHINGAN Retired Deputy Director, Higher Education, Haryana SIMPLY THE TEXT ! VRINDA PUBLICATIONS (P) LTD. 10,h,VRINDA PUBLICATIONS (P) LTD. B-5, Ashish Complex (opp. Ahlcon Public School), Mayur Vihar, Phase-I, Delhi-110... 3 41: 20150514@ toc:BRIEF CONTENTS PART ONE – INTRODUCTION 1 The Nature and Scope of Macroeconomics PART TWO – NATIONAL INCOME 2 National Income : Meaning and Measurement 3 Economic Welfare and National Income 4 National Income Accounting 5 The Circular Flow of Income PART THREE – MACROECONOMIC THEORY 6 The Classical Theory of Employment 7 Say's Law of Market 8 The Principle of Effective Demand : Aggregate Demand and Aggregate Supply 9 The Consumption Function 10 Theory of the Consumption Function 11 The Investment Function 12 The Concept of Multiplier 13 Complex Multipliers 14 Foreign Trade Multiplier 15 The Principle of Acceleration and the Super Multiplier 16 Some New Theories of Investment 17 The Saving Function 18 Saving and Investment Equality 19 The Model of National Income Determination 21 The Classical Vs. Keynesian Models of Income and Employment 22 Unemployment and Full Employment 23 Applicability of Keynes's Theory to Underdeveloped Countries PART FOUR – MONETARY THEORY 24 Money 25 Changes in the Value of Money : The Quantity Theory of Money and its Variants 26 The Keynesian Theory of Money and Prices 27 Friedman's Restatement of the Quantity Theory of Money 28 The Supply of Money 29 Credit Creation by Commercial Banks 30 Central Banking : Functions and Credit Control 31 The Monetarist Revolution 32 The Demand for Money 33 Theories of Interest Rate 34 Term Structure of Interest Rate 35 The Real Balance Effect and Pigou Effect 36 Wage-Price Flexibility and Full Employment PART FIVE – INFLATION AND BUSINESS CYCLES 37 Inflation and Deflation 38 Business Cycles PART SIX – GROWTH MODELS 39 The Harrod-Domar Models 40 The Solow-Swan Model of Growth 41 The Solow-Swan Model of Economic Growth 42 The Endogenous Growth Theory 43 Steady State Growth 44 The Golden Rule of Accumulation PART SEVEN – MACROECONOMIC POLICIES 45 Macroeconomic Policy 46 Monetary Policy 48 The Liquidity Theory of Money 49 Fiscal Policy 50 Monetarism versus Keynesianism 51 IS and LM Functions : General Equilibrium of Product and Money Market 52 Extensions of IS-LM Model 53 Effectiveness of Monetary and Fiscal Policy PART EIGHT – MODERN MACROECONOMICS 54 The Rational Expectations Hypothesis 55 Supply-side Economics 56 The New Classical Macroeconomics 57 The Real Business Cycle Theory 58 New Keynesian Economics PART NINE – MACROECONOMICS IN OPEN ECONOMY 59 Balance of Payments : Meaning and Components 60 Adjustment Mechanisms of Balance of Payments 61 Balance of Payments Policies : Internal and External Balance 62 Foreign Exchange Rate 63 Foreign Exchange Rate Policy 295,1,Part-I Introduction 296,2,CHAPTER 1 The Nature and Scope of Macroeconomics 297,w,term 'macro' was first used in economics by Ragner Frisch in 1933. 327,h,Both microeconomics and macroeconomics involve the study of aggregates. But aggregation in microecnonmics is different from that in macroeconomics. 342,3,Scope and Importance of Macroeconomics 343,4,(1) To Understand the Working of the Economy. 344,4,(2) In Economic Policies. 21 354: 20150514@ hgx:the use of macroecomomic study in the solution of certain complex economic problems. 355,5,(i) In General Unemployment. 368,5,(ii) In National Income. 369,5,(iii) In Economic Growth. 370,5,(iv) In Monetary Problems. 371,5,(v) In Business Cycles. 380,4,(3) For Understanding the Behaviour of Individual Units. 381,3,Limitations of Macroeconomics 382,4,(1) Fallacy of Composition. 391,h,But what is true of individuals is not necessarily true of the economy as a whole. 392,4,(2) To Regard the Aggregates as Homogeneous. 393,4,(3) Aggregate Variables may not be Important Necessarily. 404,4,(4) Indiscriminate Use of Macroeconomics Misleading. 405,4,(5) Statistical and Conceptual Difficulties. 406,3,Difference Between Microeconomics and Macroeconomics 428,3,Dependence of Microeconomic Theory on Macroeconomics 439,3,Dependence of Macroeconomics on Microeconomic Theory 451,3,Macro Statics, Macro Dynamics And Comparative Statics 462,h,It is a state, according to Clark, where five kinds of changes are conspicuous by their absence. The size of population, the supply of capital, methods of production, forms of business organisation and wants of the people remain constant, but the economy continues to work at steady pace. 474,h,Thus, economic statics refers to a timeless economy. 475,3,Macro Dynamics 28 486: 20150514@ hgx:Thus, economic dynamics studies the path from one equilibrium position to another 522,3,Comparative Statics 30 523: 20150514@ hgx:Comparative statics is a method of economic analysis which was first used by the German economist, F.Oppenheimer in 1916. Schumpeter described it as "an evolutionary process by a succession of static models." 524,h,different equilibrium situations are compared. 536,h,Limitations. But comparative statics is not without limitations. 537,h,1. Its scope is limited for it excludes many important economic problems. There are the problems of economic fluctuations and growth which can only be studied by the method of dynamic economics. 538,h,2. Comparative statics is unable to explain the process of change from one position of equilibrium to another. 550,h,3. We are not sure when the new equilibrium will be established 563,3,Transition from Microeconomics to Macroeconomics 586,h,general level of prices falls within the domain of macroeconomics. It 599,h,Moreover, microeconomics being based on the assumption of full employment, it failed to provide an adequate explanation of the occurrence of trade cycles. 600,h,But principles which are applicable to a particular household, firm or industry may not be applicable to the economy as a whole. 601,h,Harrod and Domar have emphasised the dual role of investment. First, it increases aggregate income, and second, it increases the productive capacity of the economy. 611,3,Stock and Flow Concepts 624,4,In Microeconomics 625,h,concepts of stock and flow are related to the demand for and supply of goods. 634,4,In Macroeconomics 635,h,Lastly, both the concepts of stock and flow variables are very important in modern theories of income, output, employment, interest rate, business cycles, etc. 660,1,Part-II National Income 661,2,CHAPTER 2 National Income : Meaning and Measurement 662,w,In common parlance 668,3,Definitions of National Income 669,4,The Marshallian Definition 680,4,The Pigouvian Definition 706,4,Fisher's Definition 707,h,Fisher adopted 'consumption' as the criterion of national income whereas Marshall and Pigou regarded it to be production. According 708,h,by Fisher, only the services rendered for use during one year by them will be included in income. If an overcoat costs Rs. 100 and lasts for ten years, Fisher will take into account only Rs. 100 as national income during one year, whereas Marshall and Pigou will include Rs. 100 in the national income for the year, when it is made. 719,4,Modern Definitions 720,h,Simon Kuznets has defined national income as "the net output of commodities and services flowing during the year from the country's productive system in the hands of the ultimate consumers." On 721,h,addition to the shares of different factors, and as net national expenditure in a country in a year's time. 731,3,Concepts of National Income 732,4,(A) Gross Domestic Product (GDP) 42 733: 20150514@ hgx:"the market value of the output of final goods and services produced in the domestic territory of a country during an accounting year." 742,h,1. The Product Method. value added method to GDP or GDP at factor cost by industry of origin. 743,h,2. The Income Method. factor incomes : Wages and Salaries (compensation of employees) + Rent + Interest + Profit. 744,h,3. Expenditure Method. 756,4,(B) GDP at Factor Cost 769,h,GDP at Factor Cost = GDP at Market Price - Indirect Taxes + Subsidies. 769,4,(C) Net Domestic Product (NDP) 770,4,(D) Nominal and Real GDP 797,4,(E) GDP Deflator 798,4,(F) Gross National Product (GNP) 807,h,First, GNP is the measure of money, in which all kinds of goods and services produced in a country during one year are measured in terms of money at current prices and then added together. 808,h,Second, in estimating GNP of the economy, the market price of only the final products should be taken into account. 820,h,Third, goods and services rendered free of charge are not included in the GNP, because it is not possible to have a correct estimate of their market price. 826,h,Fourth, the transactions which do not arise from the produce of current year or which do not contribute in any way to production, are not included in the GNP. 827,h,Fifth, the payments received under social security, e.g., unemployment insurance allowance, old age pension, and interest on public loans are also not included in GNP, 828,h,Sixth, the profits earned or losses incurred on account of changes in capital assets as a result of fluctuations in market prices are not included in the GNP 835,h,Last, the income earned through illegal activities is not included in the GNP. Although the goods sold in the black market are priced and fulfil the needs of the people, 836,4,Three Approaches to GNP 837,h,One, the income method to GNP; two, the expenditure method to GNP; and three, the value added method to GNP. Since gross income equals gross expenditure, GNP estimated by all these methods would be the same with appropriate adjustments. 838,5,1. Income Method to GNP 850,h,(i) Wages and salaries. 851,h,(ii) Rents. 852,h,(iii) Interest. 853,h,(iv) Dividends. 854,h,(v) Undistributed corporate profits. 855,h,(vi) Mixed incomes. 862,h,(vii) Direct taxes. 863,h,(viii) Indirect taxes. 864,h,(ix) Depreciation. 865,h,(x) Net income earned from abroad. 49 866: 20150514@ hgx:GNP according to the Income Method = Wages and Salaries + Rents + Interest + Dividends + Undistributed Corporate Profits + Mixed Income + Direct Taxes + Indirect Taxes + Depreciation + Net Income from abroad. 867,5,2. Expenditure Method to GNP 874,h,(i) Private consumption expenditure. 875,h,(ii) Gross domestic private investment. 877,h,(iii) Net foreign investment. 886,h,(iv) Government expenditure on goods and services. 887,5,3. Value Added Method to GNP 53 941: 20150514@ hgx:The value added method for measuring national income is more realistic than the product and income methods because it avoids the problem of double counting by excluding the value of intermediate products. 942,4,(G) GNP at Market Prices 954,4,(H) GNP at Factor Cost 55 968: 20150514@ hgx:GNP at Factor Cost = GNP at Market Prices – Indirect Taxes + Subsidies. 969,4,(I) Net National Product (NNP) 970,h,NNP = GNP— Depreciation. 971,4,(J) NNP at Market Prices 972,4,(K) NNP at Factor Cost 981,4,(L) Domestic Income 982,h,Domestic income includes : (i) Wages and salaries, (ii) rents, including imputed house rents, (iii) interest, (iv) dividends, (v) undistributed corporate profits, including surpluses of public undertakings, (vi) mixed incomes consisting of profits of unincorporated firms, self-employed persons, partnerships, etc., and (vii) direct taxes. 993,h,Domestic Income = National Income— Net income earned from abroad. 994,4,(M) Private Income 1007,h,Thus Private Income = National Income (or NNP at Factor Cost) + Transfer Payments + Interest on Public Debt — Social Security — Profits and Surpluses of Public Undertakings. 1008,4,(N) Personal Income 1009,h,Personal income differs from private income in that it is less than the latter because it excludes undistributed corporate profits. 1019,4,(O) Disposable Income 1020,h,Disposable Income = Personal Income – Direct Taxes. 1032,4,(P) Real Income 1043,h,This is also known as national income at constant prices. 1044,4,(Q) Per Capita Income 1052,3,Methods of Measuring National Income 1053,4,(1) Product Method. 1054,4,(2) Income Method. 1064,4,(3) Expenditure Method. 1065,4,(4) Value Added Method. 1080,3,Difficulties or Limitations in Measuring National Income 1081,4,(A) Problems in Income Method 1082,5,1. Owner-occupied Houses. 1083,5,2. Self-employed Persons. 1090,5,3. Goods meant for Self-consumption. 1091,5,4. Wages and Salaries paid in Kind. 1092,4,(B) Problems in Product Method 1102,5,1. Services of Housewives. 1103,h,number of goods and services which are difficult to be assessed in money terms for the reason stated above, such as painting, singing, dancing, etc. as hobbies. 1103,5,2. Intermediate and Final Goods. 1104,5,3. Second-hand Goods and Assets. 1114,5,4. Illegal Activities. 1115,5,5. Consumers' Service. 1126,5,6. Capital Gains. 1127,5,7. Inventory Changes. 1128,5,8. Depreciation. 1139,5,9. Price Changes. 1140,4,(C) Problems in Expenditure Method 1141,5,(1) Government Services. 1150,5,(2) Transfer Payments. 1151,5,(3) Durable-use Consummers' Goods. 1162,5,(4) Public Expenditure. 1163,3,Importance of National Income Analysis 1174,4,1. For the Economy. 1175,4,2. National Policies. 1176,4,3. Economic Planning. 1177,4,4. Economic Models. 1178,4,5. Research. 1179,4,6. Per Capita Income. 1186,4,7. Distribution of Income. 1187,3,Inter-Relationships Among Different Concepts of National Income 1218,3,Some Solved Problems 1303,,b,0150515 1307,2,CHAPTER 3 Economic Welfare and National Income 1308,h,h.'Welfare' is a state of the mind which reflects human happiness and satisfaction. In 1309,h,Pigou: social welfare as the sum total of individual welfares. He divides welfare into economic welfare and non-economic welfare. Economic Welfare is that part of social welfare which can directly or indirectly be measured in money. 1325,h,they spend their increased income on harmful commodities like wine, cigarettes etc. Hence, economic welfare is not an indicator of total welfare. 1326,3,Relation between Economic Welfare and National Income 1327,h,Pigou establishes a close relationship between economic welfare and national income, 1335,4,Change in the Size of National Income 1336,5,1. Change in Prices. 1346,5,2. Working Conditions. 1347,5,3. Per Capita Income. 1357,h,In other words, the rich become richer and the poor become poorer. Thus when the economic welfare of the rich increases and that of the poor decreases, the total economic welfare decreases. 1358,5,4. Method of Spending. 1368,h,Changes in Distribution of National Income. 1369,5,1. By Transfer of Wealth from the Poor to the Rich. 1379,5,2. Transfer of Wealth from the Rich to the Poor. 1380,h,Heavy taxation and progressive taxes at high rates affect adversely the productive capacity, investment and capital formation, thereby decreasing the national income. 1390,3,National Income as a Measure of Economic Welfare 1400,h,Quality of Life. 1401,h,On the other hand, in places where there is no congestion, people enjoy fresh air and the beauty of nature, the quality of life tends to increase. But this is not reflected in GNP. 1402,6,Non-market Transactions. 1403,6,Externalities. 1412,6,Nature of Production. 1413,6,Standard of Living. 1423,h,A pioneering attempt toward this direction has been made by Professors Nordhaus and Tobin2 in 1972. They have constructed a 'Measure of Economic Welfare' which they call MEW. Professor Samuelson calls it 'Net Economic Welfare', or NEW. 1424,h,"regrettable necessities", such as government expenditures on national defence, police force, road maintenance, and sanitation services, and expenses by consumers on commuting (i.e., travelling regularly by train,scooter, car or bus between one's residence and place of work). (2) All consumer expenditures on durable household goods such as washing machines, cars, TV sets, etc. which yield utility over their lifetime. (3) Estimated costs arising from "negative externalities" which are disamenities arising from urbanisation, congestion and pollution. All these reduce human welfare. 1434,h,Nordhaus and Tobin add three items to consumption. They are: (1) the value of non-market activities; (2) the estimates of the value of the services of durable consumer goods actually consumed by the owners, both households and government; and (3) the estimates of the value of leisure. 1435,h,The opportunity cost approach is based on the principle that when a person chooses to enjoy more leisure, it is always at the cost of foregoing more income. 1461,2,CHAPTER 4 National Income Accounting 1462,3,Social Accounting 1463,h,term 'social accounting' was first introduced into economics by J.R. Hicks in 1942. In 1467,3,Components of Social Accounting 1478,4,(1) Production Account. 1501,4,(2) Consumption Account. 1514,4,(3) Government Account. 1526,4,(4) Capital Account. 1536,4,(5) Foreign Account. 1558,h,functional accounts, 1559,4,Presentation of Social Accounts 1586,4,Importance of Social Accounting 1587,3,The uses of social accounting are as follows 1596,4,(1) In Classifying Transactions. 1597,4,(2) In Understanding Economic Structure. 1598,4,(3) In Understanding Different Sectors and Flows. 1599,4,(4) In Clarifying Relations between Concepts. 1607,4,(5) In Guiding the Investigator. 1607,h,(6) In Explaining Trends in Income Distribution. 1607,h,(7) In Explaining Movements in GNP. 1607,h,(8) Provide a Picture of the Working of Economy. 1607,h,(9) In Explaining Interdependence of Different Sectors of the Economy. 1619,4,(10) In Estimating Effects of Government Policies. 1619,h,(11) Helpful in Big Business Organisations. 1619,h,(12) Useful for International Purposes. 1630,4,(13) Basis of Economic Models. 1631,3,Difficulties of Social Accounting 1631,4,1. Imputations. 1631,h,2. Double Counting. 1631,h,3. Public Services. 1631,h,4. Inventory Adjustments. 1663,3,Input-Output Table 1663,h,The columns and rows of an input-output table 'provide industrial breakdowns of the final expenditures and income payments that enter into the national income accounts.' 1681,h,It may be noted that the row total must equal the column total of the economy in the input-output table. It means that total gross output must equal the total gross input of the economy. 1682,3,How to Find out GNP, GNI and GNE from the Input-Output Table? 1692,3,Input Co-efficient or Technical Co-efficient 1703,h,Xij stands for the amount absorbed by the jth industry of ith industry. 1721,h,A number of structural equations xij = aij.Xj give a summary description of the economy's existing technological conditions. The table showing input co-efficients is called "a technology matrix". 1734,3,Limitations of Input-Output Accounting Analysis 1735,4,1. Constancy of Input Coefficient Assumption Unrealistic. 1747,4,2. Factor Substitution Possible. 1748,4,3. Rigid Model. 1749,4,4. Restrictive Model. 1750,4,5. Difficulty in Final Demand. 1759,4,6. Quantity of Inputs not Constant. 1760,4,7. Solution of Equations Difficult. The 1761,3,Importance 1762,h,Despite these limitations, the concept of input-output is of tremendous practical value and importance. 1769,h,(4) The input-output model has come to be used for national income accounting "because it provides a more detailed breakdown of the macro aggregates and money flows." 1770,3,Flow of Funds Accounts 1771,h,The flow of funds accounts were developed by Prof. Morris Copeland1 in 1952 to overcome the weaknesses of national income accounting. 1828,h,1. The flow of funds accounts are more complicated than the national income accounts because they involve the aggregation of a large number of sectors with their very detailed financial transactions. 1848,3,Difference between flow of funds Accounts and National Income Accounts 1858,3,Balance of Payments Accounts 1859,4,Structure and Classification 1892,5,1. Current Account. 1904,5,2. Capital Account. 1915,5,3. The Official Settlements Account. 1927,3,Is Balance of Payments always in Equilibrium?* 110 1960: 20150515@ hgx:C + S + T = C + I + G + (X– M) or Y = C + I + G + (X– M) ( Y = C + S + T) 1983,3,Measuring Deficit or Surplus in Balance of Payments 1984,h,There are three ways of measuring deficit or surplus in the balance of payments.
First, there is the basic balance which includes the current account balance and the long-term capital account balance.
Second, there is the net liquidity balance which includes the basic balance and the short-term private non-liquid capital balance, allocation of SDRs, and errors and omissions.
Third, there is the official settlements balance which includes the total net liquid balance and short-term private liquid capital balance. 2033,2,CHAPTER 5 The Circular Flow of Income 2034,3,Circular Flow in a Two Sector Economy 2049,4,Circular Flow with Saving and Investment Added 2050,h,Expenditure has now two alternative paths from household and product markets: (i) directly via consumption expenditure, and (ii) indirectly via investment expenditure. 2057,h,Circular Flow in a Three-sector Closed Economy 2058,3,Circular Flow in a Three-sector Closed Economy 2063,h,Taxation is a leakage from the circular flow and government purchases are injections into the circular flow. 2074,h,Thus government purchases of goods and services are an injection in the circular flow of income and taxes are leakages. 2081,3,Adding Foreign Sector : Circular Flow in a Four-sector Open Economy 118 2102: 20150515@ hgx:But in the long run, exports of an economy must balance its imports. This is achieved by the foreign trade policies adopted by the economy. 2129,3,Importance of the Circular Flow 2130,h,circular flow is of immense significance for studying the functioning of the economy and for helping the government in formulating policy measures. 2131,5,1. Study of Problems of Disequilibrium. 2132,5,2. Effects of Leakages and Inflows. 2133,5,3. Link between Producers and Consumers. 2134,5,4. Creates a Network of Markets. 2140,5,5. Inflationary and Deflationary Tendencies. 2141,5,6. Basis of the Multiplier. 2142,5,7. Importance of Monetary Policy. 2151,5,8. Importance of Fiscal Policy. 2152,5,9. Importance of Trade Policies. 121 2163: 20150515@ hgx:To conclude, the circular flow of income possesses much theoretical and practical significance in an economy. 2171,1,Part-III Macroeconomic Theory 2172,2,CHAPTER 6 The Classical Theory of Employment 2173,h,The Gerneral Theory was written against the background of classical thought. By the "classicists" Keynes meant "the followers of Ricardo, those, that is to say, who adopted and perfected the theory of Ricardian economics." They included, in particular, J.S. Mill, Marshall and Pigou. 2179,3,The Classical Theory of Employment 122 2180: 20150515@ hgx:The classical economists believed in the existence of full employment in the economy. 2189,h,Its Assumptions The classical theory of output and employment is based on the following assumptions :
1. There is the existence of full employment without inflation.
2. There is a laissez-faire capitalist economy without government interference.
3. It is a closed economy without foreign trade.
4. There is perfect competition in labour and product markets.
5. Labour is homogeneous.
6. Total output of the economy is divided between consumption and investment expenditures.
7. The quantity of money is given and money is only the medium of exchange.
8. Wages and prices are perfectly flexible.
9. There is perfect information on the part of all market participants.
10. Money wages and real wages are directly related and proportional.
11. Savings are automatically invested and equality between the two is brought about by the rate of interest
12. Capital stock and technical knowledge are given.
13. The law of diminishing returns operates in production.
14. It assumes long run. 2199,h,Given these assumptions, the determination of output and employment in the classical theory occurs in labour, goods and money markets in the economy. 2208,h,Thus the very act of supplying (producing) goods implies a demand for them. It is in this way that supply creates its own demand. 2209,4,Determination of output and Employment 2210,h,Q = f (K, T, N)
where total output (Q) is a function (f) of capital stock (K), technical knowledge (T), and the number of workers (N). 2218,4,Labour Market Equilibrium 2219,h,DN = f (W/ P)
where DN = demand for labour, W = wage rate and P = price level. Dividing wage rate (W) by price level (P), we get the real wage rate (W/ P). 2246,4,Wage Price Flexibility 2247,h,This argument is based on the assumption that there is a direct and proportional relation between money wages and real wages. When money wages are reduced, they lead to reduction in cost of production and consequently to the lower prices of products. When prices fall, demand for products will increase and sales will be pushed up. Increased sales will necessitate the employment of more labour and ultimately full employment will be attained. 2281,4,Goods Market Equilibrium 2282,h,Thus saving must equal investment. If there is any divergence between the two, the equality is maintained through the mechanism of the rate of interest. To them, both saving and investment are the functions of the interest rate, 2290,4,Money Market Equilibrium 2291,h,The equation is MV = PT, where M = supply of money, V = velocity of circulation of M, P = Price level, and T = volume of transaction or total output.
The equation tells that the total money supply MV equals the total value of output PT in the economy. Assuming V and T to be constant, a change in the supply of money (M) causes a proportional change in the price level (P). Thus the price level is a function of the money supply : P = f (M). 2304,h,If the quantity of money increases, the MV curve will shift to the right as M1V curve. As a result, the price level would rise from OP to OP1, given the same level of output OQ. 2316,3,Complete Classical Model – A Summary 2317,h,The classical theory of employment was based on the assumption of full employment where full employment was a normal situation and any deviation from this was regarded as an abnormal situation. This was based on Say's Law of Market. 130 2326: 20150515@ hgx:Q = f (K, T, N). 2327,5,Labour Market Equilibrium.
demand for labour depends on total output.
The supply of labour depends on the wage rate, SL = f (W/ P),
The demand for labour also depends on the wage rate, DL = f (W/ P), 2339,5,Goods Market Equilibrium. 2341,5,Money Market Equilibrium. 2342,h,quantity of money is a function of the price level, P = f (MV). Changes in the general price level are proportional to the quantity of money. The equilibrium in the money market is shown by the equation MV = PT where MV is the supply of money and PT is the demand for money. 2354,3,Keynes's Criticism of Classical Theory 132 2355: 20150515@ hgx:General Theory. He attacked the classical theory on the following counts: 2356,h,(1) Underemployment Equilibrium. Keynes rejected the fundamental classical assumption of full employment equilibrium in the economy. 2357,h,(2) Refutation of Say's Law.
part of the earned income is saved and is not automatically invested because saving and investment are distinct functions.
Thus Keynes rejected Say's Law that supply created its own demand. Instead he argued that it was demand that created supply. When aggregate demand rises, to meet that demand, firms produce more and employ more people. 2365,h,(3) Self-adjustment not Possible. 2366,h,(4) Equality of Saving and Investment through Income 2376,h,Thus it is variations in income rather than in interest rate that bring the equality between saving and investment. 2377,h,(5) Importance of Speculative Demand for Money.
Thus the rate of interest will not fall below a certain minimum level, and the speculative demand for money would become perfectly interest elastic. This is Keynes 'liquidity trap' which the classicists failed to analyse. 2386,h,(6) Rejection of Quantity Theory of Money. 2387,h,(7) Money not Neutral.
Keynes criticised the classical view that monetary theory was separate from value theory.
Thus Keynes integrated monetary and real sectors of the economy. 2398,h,(8) Refutation of Wage-Cut. 2399,h,Moreover, social justice demands that wages should not be cut if profits are left untouched. 2408,h,(9) No Direct and Proportionate Relation between Money and Real Wages.
Moreover, institutional resistances to wage and price reductions are so strong that it is not possible to implement such a policy administratively. 2409,h,(10) State Intervention Essential.
The capitalist system is such that left to itself it is incapable of using productive power fully. Therefore, state intervention is necessary.
So Keynes favoured state action to utilise fully the resources of the economy for attaining full employment. 2419,h,(11) Long-Run Analysis Unrealistic.
Keynes had no patience to wait for the long period for he believed that "In the long-run we are all dead". As pointed by Schumpeter, "His philosophy of life was essentially a short-term philosophy."
Thus the classical theory of employment is unrealistic and is incapable of solving the present day economic problems of the capitalist world. 2438,2,CHAPTER 7 Say's Law of Market 136 2439: 20150515@ hgx:Say's law of markets is the core of the classical theory of employment.
"supply creates its own demand."
In the long-run, the economy will automatically tend toward full employment. 2444,h,Production Creates Market (Demand) for Goods. 2445,h,Barter System as its Basis. 138 2458: 20150515@ hgx:General Overproduction Impossible. 2458,h,Saving-Investment Equality. 2458,h,Rate of Interest as a Determinant Factor. 2458,h,Labour Market. 2458,h,Unemployment results from rigidity in the wage structure and interferences in the working of the free market economy. 2481,3,Propositions and Implications of the Law 2482,4,1. Full Employment in the Economy. 2482,h,2. Proper Utilization of Resources. 2482,h,3. Perfect Competition. 2493,5,(a) Size of the Market. 2493,h,(b) Automatic Adjustment Mechanism. The 2493,h,(c) Role of Money as Neutral. 2493,4,4. Laissez-faire Policy. 2493,h,5. Saving as a Social Virtue. 2504,3,Criticisms of Say's Law 2504,h,J.M. Keynes in his General Theory made a frontal attack on the classical postulates and Say's law of markets. He criticised Say's law of markets on the following grounds: 2504,4,1. Supply does not Create its Demand.
demand does not increase as much as production increases. 2504,h,2. Self-adjustment not Possible. 2504,h,3. Money is not Neutral. 2504,h,4. Over Production is Possible. 2504,h,5. Underemployment Situation. 2504,h,6. State Intervention. 2526,h,Keynes, therefore, advocated state intervention for adjusting supply and demand within the economy through fiscal and monetary measures. 2527,4,7. Equality through Income. 2527,h,8. Wage-cut no Solution. 2527,h,9. Demand Creates its own supply. 2537,h,Unemployment results from the deficiency of effective demand because people do not spend the whole of their income on consumption. 2545,2,CHAPTER 8 The Principle of Effective Demand : Aggregate Demand and Aggregate Supply 2546,h,The logical starting point of Keynes's theory of employment is the principle of effective demand. 2549,3,Effective Demand 2550,h,according to Keynes, the level of employment is determined by effective demand which, in turn, is determined by aggregate demand price and aggregate supply price. 2551,4,Aggregate Demand Price 2560,h,"The aggregate demand function," according to Keynes, "relates any given level of employment to the expected proceeds from that level of employment." Table I shows the aggregate demand schedule. 2572,4,Aggregate Supply Price 2602,4,Determination of Effective Demand 2603,h,The level of employment is determined at the point where the aggregate demand price equals the aggregate supply price. 2648,h,supply function to be given because it depends on the technical conditions of production, the availability of raw materials, machines etc. which do not change in the short run. It is, therefore, the aggregate demand function which plays a vital role in determining the level of employment in the economy. 2655,3,Importance of Effective Demand 2656,h,It is the soul of the Keynesian theory of employment. Dr Klein attributes the Keynesian revolution solely to the development of a theory of effective demand. 2667,5,1. Determinant of Employment. 2668,h,Thus unemployment is caused by a deficiency of effective demand. 2669,h,In brief, Effective Demand = Value of National Output = Volume of Employment = National Income = National Expenditure = Expenditure on consumption goods + Expenditure on investment goods. 2679,h,importance of the principle of effective demand lies in pointing out the cause and remedy of unemployment. Unemployment is caused by a deficiency of effective demand and it can be removed by an increase in consumption expenditure or/ and investment expenditure and in case the private expenditures are insufficient and ineffective in bringing about the required level of employment, the same can be achieved by government expenditure. Thus the principle of effective demand is the basis of the theory of employment. 2680,5,2. Repudiation of Say's Law and Full Employment Thesis. 2681,h,that underemployment equilibrium is a normal situation and full employment equilibrium is accidental. 2690,5,3. Role of Investment. 2691,h,Therefore, the level of effective demand and hence of employment can be raised by an increase in investment. In this lies the importance of investment. 2692,5,4. The Paradox of Poverty in the midst of Potential Plenty. 2701,h,It follows that in a poor community, the gap between income and consumption is small because the marginal propensity to consume is high. It will, therefore, have little difficulty in employing all its resources by filling the gap through small investment expenditure. 2702,h,On the contrary, in a wealthy community the gap between income and consumption is very large because the marginal propensity to consume is low. It will, therefore, require large investment expenditure to fill the gap between income and consumption in order to maintain a high level of income and employment. But in a rich community investment demand is not adequate to fill this gap and there emerges a deficiency of aggregate demand resulting in widespread unemployment. When the aggregate demand falls, the potential wealthy community will be forced to reduce its actual output until it becomes so poor that the excess of output over consumption will be reduced to the actual amount of investment. Further, in such a community there is an accumulated stock of capital assets which weakens the inducement to invest because every new investment competes with an already existing large supply of old capital assets. 2723,2,CHAPTER 9 The Consumption Function 2724,3,Meaning of Consumption Function 2729,h,The consumption function or propensity to consume refers to income-consumption relationship. It is a "functional relationship between two aggregates, i.e., total consumption and gross national income." 1 Symbolically, the relationship is represented as C = f (Y), where C is consumption, Y is income, and f is the functional relationship. 2750,h,income, C1C2 < Y1Y2. The portion of income not consumed is saved as shown by the vertical distance between 45 ° line and C curve, i.e., SS1. "Thus the consumption function measures not only the amount spent on consumption but also the amount saved. This is because the propensity to save is merely the propensity not to consume. The 45 ° line may therefore be regarded as a zero-saving line, and the shape and position of the C curve indicate the division of income between consumption and saving." 2751,3,Properties or Technical Attributes of the Consumption Function 2766,5,(1) The Average propensity to Consume. 2780,5,(2) The Marginal Propensity to Consume. 155 2781: 20150515@ hgx:MPC = ? C/ ? Y. 2782,4,Significance of MPC 2798,h,Keynes is concerned primarily with the MPC, for his analysis pertains to the shor-run while the APC is useful in the long-run analysis. 2799,h,The Keynesian hypothesis that the marginal propensity to consume is positive but less than unity( O < ? C/ ? Y < 1) is of great analytical and practical significance. Besides "( a) the theoretical possibility of general over production or 'underemployment equilibrium,' and also (b) the relative stability of a highly developed industrial economy. 2814,3,Keynes's Psychological Law of Consumption 2815,5,Propositions of the Law 2816,h,three related propositions: (1) When income increases, consumption expenditure also increases but by a smaller amount. The reason is that as income increases, our wants are satisfied side by side, so that the need to spend more on consumer goods diminishes. 2826,5,(2) The increased income will be divided in some proportion between consumption expenditure and saving. 2827,5,(3) Increase in income always leads to an increase in both consumption and saving. This 2846,4,Its Assumptions 2847,5,1. It assumes a Constant Psychological and Institutional Complex. 2869,h,assumption that the psychological and institutional complexes influencing consumption expenditure remain constant. Such complexes are income distribution, tastes, habits, social customs, price movements, population growth, etc. In the short run, they do not change and consumption depends on income alone. 2870,5,2. It assumes the Existence of Normal Conditions. 2871,h,If, however, the economy is faced with abnormal and extraordinary circumstances like war, revolution or hyperinflation, the law will not operate. People may spend the whole of increased income on consumption. 2872,5,3. It assumes the Existence of a Laissez-faire Capitalist Economy. 2873,h,People should be free to spend increased income. 2880,3,Implications of Keynes's Law (or Importance of the Consumption Function) 2881,4,1. Invalidates Say's Law. 2882,h,Keynes's psychological law invalidates Say's Law because as income increases, consumption also increases but by a smaller amount. 2883,4,2. Need for State Intervention. 2883,h,As a corollary to the above, the psychological law highlights the need for state intervention. Say's Law is based on the existence of laissez-faire policy and its refutation implies that the economic system is not self-adjusting. 2891,4,3. Crucial Importance of Investment. 2892,4,4. Existence of Underemployment Equilibrium. 2901,4,5. Declining Tendency of the Marginal Efficiency of Capital. 2902,4,6. Danger of Permanent Over-saving or Under-investment Gap. 2914,h,This long-run tendency of increase in saving and fall in investment is characterised as secular stagnation. 2915,4,7. Unique Nature of Income Propagation. 2916,4,8. Explanation of the Turning Points of the Business Cycles. 2926,h,People continue to buy consumer goods even when their income falls. So when the excess stock of commodities is exhausted in the community during a depression, the existence of consumer expenditure on goods leads to revival. 2942,3,Determinants of the Consumption Function 2943,h,influence the consumption function and determine its slope and position. They are (i) the subjective factors, and (ii) the objective factors. 2944,h,The objective factors are exogenous or external to the economic system. They may, therefore, undergo rapid changes and may cause marked shifts in the consumption function (i.e., the C curve). 2945,4,Subjective Factors 2952,5,1. Individual Motives. 2953,h,(i) the desire to build reserves for unforeseen contingencies;
(ii) the desire to provide for anticipated future needs,
(iii) the desire to enjoy and enlarged future income by way of interest and appreciation;
(iv) the desire to enjoy a gradually increasing expenditure in order to improve the standard of living;
(v) the desire to enjoy a sense of independence and power to do things;
(vi) the desire to secure a "masse de manoeuver" to carry out speculative or business projects;
(vii) the desire to bequeath a fortune;
(viii) the desire to satisfy a pure miserly instinct. 2963,5,2. Business Motives. 2962,h,(i) enterprise, the desire to do big things and to expand;
(ii) liquidity, the desire to meet emergencies and difficulties successfully;
(iii) income raise, the desire to secure large income and to show successful management;
(iv) financial prudence, the desire to provide adequate financial resources against depreciation and obsolescence, and to discharge debt. 2964,4,Objective Factors 2965,5,1. Changes in the Wage Level. 2974,h,If, however, the rise in the wage rate is accompanied by a more than proportionate rise in the price level, the real wage rate will fall and it will tend to shift the C curve downward. A cut in the wage rate will also reduce the consumption function of the community 2975,5,2. Windfall Gains or Losses. 2976,5,3. Changes in the Fiscal Policy. 2977,h,taxation adversely affect the consumption function by reducing the disposable income of the people. This is what actually happened during the Second World War when the consumption function shifted downward due to heavy indirect taxation, rationing and price controls. 2985,5,4. Changes in Expectations. 2986,5,5. Changes in the Rate of Interest. 2996,5,6. Financial Policies of Corporations— Financial 2997,5,7. Holding of Liquid Assets. 3008,5,8. The Distribution of Income. 3010,5,9. Attitude toward Saving. 3019,5,10. Duesenberry Hypothesis. 3020,h,'demonstration effect.' There is a tendency in human beings not only to keep up with the Joneses but also to surpass the Joneses, 3021,3,Measures to Raise the Propensity to Consume 3030,5,1. Income Redistribution. 3041,5,2. Increased Wages. 3042,5,3. Social Security Measures. 3043,h,therefore, provide larger social security measures to raise the propensity to consume of the people. 3053,5,4. Credit Facilities. 3054,5,5. Advertisement. 3055,5,6. Development of the Means of Transport. 3056,5,7. Urbanisation. 3072,5,Exercises 3073,h,"Keynes's discovery of the consumption function must be regarded as one of the major breakthroughs of modern economics." Discuss.
"Keynes's consumption function is an epoch making tool in economic analysis." Discuss.
"Keynes's consumption function is an epoch-making contribution to the tools of economic analysis." 3077,2,CHAPTER 10 Theory of the Consumption Function 3078,3,Keynes' Consumption Function : The Absolute Income 3113,4,Empirical Studies 3114,3,The Consumption Puzzle 3134,3,The Drift Theory of Consumption 3149,h,Smithies and Tobin discuss the following factors: 3150,5,1. Asset Holdings. 3151,5,2. New Products. 3152,5,3. Urbanisation. 3161,5,4. Age Distribution. 3162,5,5. Decline in Saving Motive. 3163,5,6. Consumer Credit. 3164,5,7. Expectation of Income Increasing . 3185,4,Its Criticisms 3186,5,1. The theory does not tell the rate of upward drift along the CL curve. It appears to be a matter of chance. 3187,5,2. It is just a coincidence if the factors explained above cause the consumption 3196,3,The Relative Income Hypothesis 3196,h,"social character of consumption paterns" 3208,h,when income decreases, consumption does not fall in the same proportion because of the Ratchet Effect. 32009,4,The Ratchet Effect 3210,h,"past peak of income" 3260,4,Its Criticisms 3261,5,1. No Proportional Increase in Consumption. 3262,5,2. No Direct Relation between Consumption and Income. 3277,5,3. Distribution of Income not Unchanged. 3278,5,4. Reversible Consumer Behaviour. 3279,5,5. Neglects Other Factors. 3289,5,6. Consumer Preferences do not Depend on Others. 3290,5,7. Reverse Lightning Bolt Effect. 3298,2,The Permanent Income Hypothesis 3299,h,Ym or
Y = YP + Yt ...( 1)
and C = CP + Ct ...
( 2)
where p refers to permanent, t refers to transitory, Y to income and C to consumption. 3386,h,Friedman gives a series of assumptions concerning the relationships between permanent and transitory components of income and consumption. 3387,h,1. There is no correlation between transitory income and permanent income.
2. There is no correlation between permanent and transitory consumption.
3. There is no correlation between transitory consumption and transitory income.
4. Only differences in permanent income affect consumption systematically. 3388,3,Explanation of the Theory 3411,4,Its Criticisms 3412,5,1. Correlation between Temporary Income and Consumption. 3413,5,2. APC of all Income Groups not Equal. 3414,5,3. Use of Various terms Confusing. 3428,5,4. No Distinction between Human and Non-human Wealth. 3429,5,Conclusion. 192 3430: 20150515@ hgx:Despite these weaknesses, "it can be fairly said", 3438,3,The Life Cycle Hypothesis 3439,4,Its Assumptions 3440,h,The life cycle hypothesis is based on the following assumptions: 193 3452: 20150515@ hgx:1. There is no change in the price level during the life of the consumer.
2. The rate of interest paid on assets is zero.
3. The consumer does not inherit any assets and his net assets are the result of his own savings.
4. His current savings result in future consumption.
5. He intends to consume his total lifetime earnings plus current assets.
6. He does not plan any bequests.
7. There is certainty about his present and future flow of income.
8. The consumer has a definite conscious vision of life expectancy.
9. He is aware of the future emergencies, opportunities and social pressures which will impinge upon his consumption spending.
10. The consumer is rational. 3508,4,Its Implications 3518,h,1. The life cyclehypothesis solves the consumption puzzle. 3521,h,2. The life cycle hypothesis reveals that savings change over the life time of a consumer. 3522,h,3. The life cycle hypothesis also implies that a high-income family consumes a smaller proportion of his income 3537,4,Its Criticisms 3538,5,1. Plan for Lifetime Consumption Unrealistic. 3539,5,2. Consumption not directly related to Assets. 3540,5,3. Consumption depends on Attitude. 3541,5,4. Consumer not Rational and Knowledgeable. 3547,5,5. Estimation of Variables not Possible. 3548,5,6. Liquidity Constraints. 198 3549: 20150515@ hgx:Conclusion. Despite these, the life cycle hypothesis is superior to the other hypotheses on consumption function because it includes not only wealth as a variable in the consumption function but also explains why APC > MPC in the short-run and APC is constant in the long-run. 3585,2,CHAPTER 11 The Investment Function 200 3586: 20150515@ But this is not real investment because it is simply a transfer of existing assets. Hence this is called financial investment which does not affect aggregate spending. In Keynesian terminologyinvestment refers to real investment which adds to capital equipment. It leads to increase in the levels of income and production by increasing the production and purchase of capital goods. Investment thus includes new plant and equipment, construction of public works like dams, roads, buildings, etc., net foreign investment, inventories 3572,h,Thus capital is a stock concept. 3585,3,Types of Investment 3586,4,Induced Investment. 3597,h,(i) The average propensity to invest is the ratio of investment to income, 3588,h,(ii) The marginal propensity to invest is the ratio of change in investment to the change in income, 3615,3,The Present Value (PV) Criterion of Investment 3640,4,Accept or Reject Criterion 3648,h,Merits NPV method has the following merits:
(i) This method considers time value of money.
(ii) It considers the cash flows of the project in different time periods.
(iii) It is more scientific than traditional methods. 3658,h,Demerits There are also some demerits of this method:
(i) It is difficult to calculate the profit cost with this method.
(ii) It is difficult to work out especially the cost of equity capital by this method.
(iii) It is not applicable without the knowledge of cost of capital.
(iv) It favours long-run investment projects.
(v) When projects with different investments are compared, this method does not give correct result.
(vi) Its assumption that the intermediate cash flows are reinvested on the capital cost of the firms, is not always true.
(vii) This method gives different rankings in the case of complicated projects in comparison to other methods. 3659,3,Determinants Of The Level Of Investment 3667,4,Marginal Efficiency of Capital (MEC) 3740,4,Marginal Efficiency Of Investment (MEI) 3883,3,Factors Other Than The Interest Rate Affecting Inducement To Invest 3884,4,(1) Element of Uncertainty. 3916,4,(2) Existing Stock of Capital Goods. 3917,4,(3) Level of Income. 3918,4,(4) Consumer Demand. 3916,4,(2) Existing Stock of Capital Goods. 3930,4,(5) Liquid Assets. 3931,4,(6) Inventions and Innovations. 3932,h,The absence of new technologies will mean low inducement to invest. 3941,4,(7) New Products. 3942,4,(8) Growth of Population. 3943,4,(9) State Policy. 3953,4,(10) Political Climate. 3963,2,CHAPTER 12 The Concept of Multiplier 3964,h,concept of multiplier was first developed by R.F. Kahn in his article "The Relation of Home Investment to Unemployment" in the Economic Journal of June 1931. 3965,3,The Investment Multiplier 3966,4,The multiplier, according to Keynes,"establishes a precise relationship, given the propensity to consume, between aggregate employment and income and the rate of investment. 3970,4,i.e., ? Y = K ? I. In the words of Hansen, Keynes' investment multiplier is the coefficient relating to an increment of investment to an increment of income, i.e., K = ? Y/ ? I, 3992,4,Working of the Multiplier 3993,4,Forward Operation 4026,4,Backward Operation 4055,4,Assumptions of Multiplier 4056,h,(1) There is change in autonomous investment and that induced investment is absent.
(2) The marginal propensity to consume is constant.
(3) Consumption is a function of current income.
(4) There are no time lags in the multiplier process. An increase( decrease) in investment instantaneouly leads to a multiple increase( decrease) in income.
(5) The new level of investment is maintained steadily for the completion of the multiplier process.
(6) There is net increase in investment.
(7) Consumer goods are available in response to effective demand for them.
(8) There is surplus capacity in consumer goods industries to meet the increased demand for consumer goods in response to a rise in income following increased investment.
(9) Other resources of production are also easily available within the economy.
(10) There is an industrialised economy in which the multiplier process operates.
(11) There is a closed economy unaffected by foreign influences.
(12) There are no changes in prices.
(13) The accelerator effect of consumption on investment is ignored.
(14) There is less than full employment level in the economy. 4068,4,Leakages of Multiplier 4078,5,1. Saving. 4079,5,2. Strong Liquidity Preference. 4080,5,3. Purchase of Old Stocks and Securities. 4090,5,4. Debt Cancellation. 4091,5,5. Price Inflation. 4092,5,6. Net Imports. 4093,5,7. Undistributed Profits. 4101,5,8. Taxation. 4102,5,9. Excess Stocks of Consumption Goods. 4103,5,10. Public Investment Programmes. 4113,4,Criticism of Multiplier 4114,5,1. Merely Tautological Concept. 4115,5,2. Timeless Analysis. 4115,h,time lag is always involved between the receipt of income and its expenditure on consumption goods 4125,5,3. Worthless Theoretical Toy. 4126,5,4. Acceleration Effect Ignored. 4127,h,Hicks, Samuelson and others have shown that it is the interaction of the multiplier and the accelerator which helps in controlling business fluctuations. 4128,5,5. MPC does not Remain Constant. 4137,5,6. Relation between Consumption and Income. 4149,4,Importance of Multiplier 4150,5,1. Investment. The multiplier theory highlights the importance of investment in income and employment theory. 4151,5,2. Trade Cycle. 4160,h,Thus the multiplier is regarded as an indispensable tool in trade cycles. 4161,5,3. Saving-Investment Equality. 4162,5,4. Formulation of Economic Policies. 4163,h,(a) To achieve full employment. 4164,h,(b) To control trade cycles. The 4172,h,(c) Deficit financing. 4173,h,(d) Public investment. 4174,h,economic activity cannot be left to the vagaries and uncertainties of private enterprise. Hence, the importance of multiplier in public investment lies in creating or controlling income and employment. The state can have the greatest multiplier effect on income and employment by increasing public investment during a depression where the MPC is high (or the MPS is low). 4183,3,The Dynamic or Period Multiplier 4194,h,The dynamic multiplier relates to the time lags in the process of income generation. 4240,3,The Employment Multiplier 4286,2,CHAPTER 13 Complex Multipliers 4292,3,Government Expenditure Multiplier 4309,3,Tax Multipliers 4328,3,Balanced Budget Multiplier 4408,4,Its Limitations 4409,4,Its Critical Appraisal 4437,2,CHAPTER 14 Foreign Trade Multiplier 4444,4,Its Working 4445,h,with, the exporters will sell their products to foreign countries and receive more income. In order to meet the foreign demand, they will engage more factors of production to produce more. 4471,4,Its Assumptions 4472,h,1. There is full employment in the domestic economy.
2. There is direct link between domestic and foreign country in exporting and importing goods.
3. The country is small with no foreign repercussion effects.
4. It is on a fixed exchange rate system.
5. The multiplier is based on instantaneous process without time lags.
6. There is no accelerator.
7. There are no tariff barriers and exchange controls.
8. Domestic investment (Id ) remains constant.
9. Government expenditure is constant. 4482,4,Diagrammatic Explanation 4497,4,Foreign Repercussion or Backwash Effect 4540,4,Implications of Foreign Repercussion 4553,4,Criticisms of Foreign Trade Multiplier 4554,5,1. Exports and Investment not Independent. 4555,5,2. Lagless Analysis. 4564,5,3. Full Employment not Realistic. 4565,5,4. Not Applicable to More than two Countries. 4566,5,5. Neglects Trade Restrictions. 4567,5,6. Neglects Monetary-Fiscal Measures. 4581,2,CHAPTER 15 The Principle of Acceleration and the Super Multiplier 4582,h,The term “acceleration principle” itself was first introduced into economics by J. M. Clark1 in 1917. It was further developed by Hicks, Samuelson, and Harrod in relation to the business cycles. 4583,3,The Principle of Acceleration 4604,h,The acceleration principle can be expressed in the form of the following equation. 2
Igt = v (Yt– Yt– 1 ) + R
= v ? Yt + R
where Igt is gross investment in period t, v is the accelerator, Yt is the national output in period t, Yt-1 is the national output in the previous period (t— 1), and R is the replacement investment. 4672,4,Criticisms 4673,5,1. Capital-Output Ratio not Constant. The acceleration principle is based on a constant capital-output 4682,5,2. Resources not Elastic. 4683,5,3. Idle Capacity in Plants. 4684,5,4. Difference between Required and Real Capital Stock. 4693,5,5. Does not Explain Timing of Investment. 4694,5,7. Acceleration Effect Zero for Installed Equipment. 4695,5,8. Does not Work for Temporary Demand. 4704,5,9. Supply of Credit not Elastic. 4705,5,10. Neglects Profits as a Source of Internal Funds. 4706,5,11. Neglects the Role of Expectations. 4716,5,12. Neglects the Role of Technological Factors. 4717,5,13. Fails to Explain Lower Turning Point. 4718,5,14. Not Precise and Satisfactory. 4719,h,Conclusion. Despite these limitations, the principle of acceleration makes the process of income propagation clearer and more realistic than the multiplier theory. The multiplier shows the effect of a change in investment on income via consumption while the acceleration shows the effect of consumption or output on investment and income. 4728,3,The Super-Multiplier or the Multiplier-Accelerator Interaction 4781,3,Use of Multiplier-Accelerator Interaction in Business Cycles 4842,2,CHAPTER 16 Some New Theories of Investment 4843,h,First, the classical theory that investment is a function of the rate of interest. Second, the Keynesian theory that investment is a function of income and rate of interest. Third, the acceleration theory that investment is a function of the change in output or income. 4849,3,The Accelerator Theory of Investment 4879,3,The Flexible Accelerator Theory or Lags in Investment 4893,h,the capital stock adjustment model.
Koyck.
the decision-making lag.

administrative lag
financial lag
delivery lag 4910,4,Koyck's Approach 4911,h,Koyck's approach to the flexible accelerator assumes that the actual capital stock depends on all past output levels with weights declining geometrically. Accordingly, Kt = (1 – ? ) vYt + ?Kt– 1 4925,4,Koyck transformation. 4933,h,The net investment (Kt – Kt– 1 ) is called the distributed lag accelerator which is inversely related to the capital stock of the previous period and is positively related to the output level. 4933,h,flexible accelerator or the stock adjustment principle. 4951,h,Its Comparison with Naive Accelerator 4959,3,The Profits Theory of Investment 4960,h,liquidity version of the profits theory. 4970,h,Kt* = f (p t– 1)
where Kt* is the optimal capital stock and f ( p t– 1) is some function of past actual profits. 5014,4,Its Criticism 5032,3,Duesenberry's Accelerator Theory of Investment 5033,h,Business Cycles and Economic Growth: investment as a function of income (Y), capital stock (K), profits (p) and capital consumption allowances (R). All these are independent variables and can be represented as
I = f (Yt– 1, Kt– 1, pt– 1, Rt ) 5051,h,It = a Yt– 1 + ß Kt– 1 5052,h,Ct = f (Yt– 1 – p t– 1 – Rt– 1 + dt ) 5071,h,Kt = (1– k) Kt– 1 + It 5084,h,This is a generalised version of a multiplier-accelerator process. 5087,h,Thus an increase in income will have a smaller immediate effect on expenditure than would occur in a simple multiplier-accelerator model. 5102,3,The Financial Theory of Investment 284 5103: 20150515@ hgx:the cost of capital theory of investment. 5113,4,Sources of Funds 5114,h,internal funds and external funds. 5115,5,1. Retained Earnings. 5124,5,2. Borrowed Funds. 5125,5,3. Equity Issue. 5126,4,Cost of Funds 5183,4,Its Criticisms 5184,5,1. The results of studies by Meyer and Kuh on invesment behaviour of firms show that when demand is expanding rapidly, 5193,5,2. Meyer and Kuh found that firms take a longer view while making investment spending, whereas Duesenberry explains a short-run model of investment. 5194,5,3. Empirical evidence in the theory of investment by Kuh and Meyer8 shows that monetary policy is the least effective of all the macroeconomic policy instruments. In the analysis represented in Figure 10, 5206,5,4. This theory neglects the role of fiscal policy in investment 5207,3,Jorgensons' Neoclassical Theory of Investment 5229,h,Jorgenson develops his theory of investment on the assumption that the firm maximises its present value. 5335,3,Tobin's q Theory of Investment 5336,h,which links a firm's investment decisions to fluctuations in the stock market. When a firm finances its capital for investment by issuing shares in the stock market, its share prices reflect the investment decisions of the firm. Firm's investment decisions depend on the following ratio, called Tobin'sq: The market value of firm's capital stock in the numerator is the value of its capital as determined by the stock market. 5345,h,According to Tobin, net investment would depend on whether q is greater than (q > 1) or less than 1 (q < 1). If q > 1, the market value of the firms shares in the stock market is more than the replacement cost of its real capital, machinery etc. The firm can buy more capital and issue 5379,4,Exercises 5380,h,
  1. Summarise the accelerator theory of investment and provide examples of situations when this theory will not work.
  2. Critically discuss the accelerator theory of investment.
  3. Explain the flexible theory of investment.
  4. Explain how adjustment is made when there are lags between levels of output and capital stock in the theory of accelerator.
  5. Explain the profits theory of investment.
  6. Explain the “cost of funds” theory of investment.
  7. How has Duesenberry integrated the accelerator principle with the profits theory of investment?
  8. Explain the financial theory of investment.
  9. Critically examine the neoclassical theory of investment.
  10. Explain Tobin's q of theory of investment.
5387,2,CHAPTER 17 The Saving Function 5388,3,Meaning of Saving Function 5412,4,The Average Propensity to Save (APS) 5424,4,The Marginal Propensity to Save (MPS) 5440,3,Determinants of Savings 5441,4,(a) Will to Save 5442,5,1. Family Affection. 5452,5,2. Precaution. 5453,5,3. Standard of Living. 5454,5,4. Farsightedness. 5455,5,5. Calculating Mind. 5456,5,6. Enterprise. 5463,5,7. Independent. 5464,5,8. Social Status. 5465,5,9. Miserliness. 5466,4,(b) Power to Save 5474,5,1. Size of National Income. 5475,5,2. Natural Resources. 5476,5,3. Trade. 5477,5,4. Industrial Development. 5485,5,5. Agricultural Development. 5486,5,6. Efficiency of Labour. 5487,5,7. Distribution of Wealth and Income. 5488,4,(c) Facilities to Save 5489,5,1. Peace and Security. 5490,5,2. Banking Facilities. 5496,5,3. Taxation Policy. 5497,5,4. Value of Money. 5498,5,5. Investment Opportunities. 5499,5,6. Economic Policy of Government. 5508,3,The Paradox of Thrift 5545,2,CHAPTER 18 Saving and Investment Equality 5546,3,The Classical View 5560,4,Keynes’s Criticism of the Classical View 5561,h,(a) Keynes does not agree with the classical view that the equality between saving and investment is brought about through the mechanism of the interest rate. 5576,3,The Keynesian View 5577,4,(1) The Accounting or Definitional Equality 5602,h,Thus saving and investment are the same thing. They are both the difference between income and consumption. So defined, they are always equal. 5603,h,Criticism. This equality or rather identity between saving and investment which Keynes established in his General Theory has been severely criticised. 5603,5,1. Relationship a Truism. 5604,5,2. Decisions taken by Different People. 5613,5,3. Lagless Analysis. 5614,5,4 Does not distinguish between Financial Sources. 5615,4,(2) The Functional Equality 5653,3,Other Views 5654,4,The Robertsonian Approach 5666,h,But Professor Klein does not agree with Lutz that the Robertsonian analysis of saving and investment is dynamic in the true sense. In his words: "Robertson's definitions are dynamic only in the most trivial sense. 5676,4,The Swedish Approach 318 5702: 20150515@ hgx:L.R. Klein, The Keynesian Revolution, 1952. 5716,2,CHAPTER 19 The Model of National Income Determination 5717,3,Two-Sector Model 5754,4,Equality of Aggregate Demand and Aggregate Supply 5778,4,Equality of Saving and Investment 5836,3,Three Sector Model 5837,4,Government Expenditure 5855,h,a lumpsum tax
proportional tax 5879,4,Effect on Saving and Investment 5890,3,Four Sector Model : Income Determination In Open Economy 5903,4,Assumptions
The analysis of the determination of income in an open economy is based on the following assumptions:
  1. 1. The domestic economy’s international trade is small relative to total world trade.
  2. 2. There is less than full employment in the economy.
  3. 3. The general price level is constant upto the full employment level.
  4. 4. Exchange rates are fixed.
  5. 5. There are no tariffs, trade and exchange restrictions.
  6. 6. Gross exports are determined by external factors.
  7. 7. Exports (X), investment (I) and goverment expenditure (G) are autonomous.
  8. 8. Consumption (C), imports (M), savings (S) and taxes (I) are each a fixed proportion of national income (Y) and their relationships with national income are linear.
5967,2,CHAPTER 20 The Keynesian Theory of Income, Output and Employment: A Summary 5972,3,The Keynesian Theory of Income, Output and Employment 6059,4,Exercises 6074,h,
  1. How is equilibrium level of income determined under the Keynesian system ?
  2. Is it possible to have equilibrium in the level of national income without achieving full employment ?
  3. "The level of employment is determined by the level of income which in turn depends upon aggregate demand." Comment.
  4. Explain Keynes's under-employment equilibrium.
6078,2,CHAPTER 21 The Classical Vs. Keynesian Models of Income and Employment 6079,3,General Theory: Evolutionary or Revolutionary 339 6080: 20150515@ hgx:Keynes’s General Theory of Employment, Interest and Money in 1936. 6084,h,Keynes also did the same thing. He accepted the classical theory, criticised and extended it and at the same time rejected parts of it. The main elements of the General Theory can be found embryonic form in the works of his predecessors but Keynes’s novelty lies in giving them a new complexion. As rightly observed by Harris, "Out of the straws of his predecessors, with some additions of his own, he had built a structure which no economist or economic practitioner can afford not to inspect or use." No doubt the Keynesian economics is built on the classical economics but it differs significantly from the latter in terms of assumptions, presentation of tools of analysis and policy measures. 6097,h,The following points mark Keynesian theory as revolutionary and a genuine departure from the classical economics. 6098,5,(1) Full Employment. 6099,5,(2) Say's Law. 6109,h,"Keynes's greatest achievement," according to Prof. Sweezy "was the liberation of Anglo-American economics from this tyrannical dogma." 2 Keynes propounded the opposite view that demand creates its own supply. 6110,h,"Consumption function is an epoch making contribution to the tools of economic analysis." 6111,5,(3) Laissez-Faire. 6112,h,He, therefore, favoured state intervention and stressed the importance of public investment to fill the gap created by the deficiency of private investment. "Viewing Keynes's theory as a whole, its revolutionary nature lies," according to Prof. Dillard, "in the repudiation of any presumption in favour of laissez-faire." 6123,5,(4) Wage Cut. 6124,5,(5) Saving. 6125,5,(6) Saving-Investment Equality. 6136,5,(7) Trade Cycles. 6137,h,"Keynesian revolution commands the field." 6138,5,(8) Monetary Theory. 6147,5,(9) Macro Analysis. 6148,5,(10) Saving Capitalism. 6159,5,(11) Policies. 6160,h,We may conclude that the General Theory is not evolutionary but is revolutionary in both economic thought and policy and is a genuine departure from the classical thought. 6161,3,Criticisms of Keynesian Theory 6171,5,(1) Aggregate Demand. 6172,5,(2) Aggregate Supply. 6183,h,another fallacious by-product of the usual Keynesian neglect of the supply side of the commodity market." 6183,5,(3) Effective Demand. 6184,h,According to Prof. Burns, the determination of Keynes's theory in terms of effective demand "reflects a pleasant but dangerous illusion." 6185,5,(4) Consumption Function. 6186,h,epoch-making contribution to the tools of economic analysis yet it is not free from defects. 6195,5,(5) Investment Function. 6207,h,Thus Keynes ignores the impact of technology on the economy. 6208,5,(6) Rate of Interest. 6209,h,There is “money illusion” in the Keynesian speculative demand for money which means that the increased supply of money is absorbed only at a lower rate of interest. 6218,h,Further, Keynes failed to consider the influence of price expectations on the demand for money. 6219,5,(7) Expectations. 6220,h,Keynes has been criticised for his over emphasis on expectations. Expectations breed uncertainty. 6230,5,(8) Saving and Investment. 6231,5,(8) Wages. 6242,h,decrease in labour input without requiring a priori increase in real wage rate." 6243,5,(10) Business Cycles. 6244,h,"Keynes's explanation of the crisis of the marginal efficiency of capital is either a useless truism or an obvious error." 6245,h,One of the serious omissions of Keynes’s theory is the acceleration principle. This made his theory of business cycles one-sided because his explanation centres round the principle of multiplier. 6255,5,(11) Dynamic Theory. 6256,h,"The 'dynamic' nature of Keynes' shifting equilibrium suggests that he is thinking dynamically, since there can be no shift from one position of equilibrium to another without prior movements of variables through time. Keynes made no attempt to show the process of transition from one position of equilibrium to another, however. His method of comparing different equilibrium levels of income has been termed comparative statics. Prof. Ackley calls the Keynesian model as "too static." 6257,5,(12) Short-run Economics. 6258,5,short-run. Keynes himself remarked, “In the long-run, we are all dead.” 6267,5,(13) Too Aggregative. 6268,5,(14) Closed Economy. 6269,h,Keynes’ analysis unrealistic because all economies are open economies, and foreign trade has an important impact on their level of employment. 6278,5,(15) Perfect Competition. 6279,5,(16) General Theory. 6280,h,it is not a general theory but a special theory which is applicable only under static conditions in a perfectly competitive closed economy. 6289,h,"Those who seek universal truths applicable in all places and at all times, had better not waste their time on the General Theory." 6290,5,(17) Problem of Unemployment. 6291,5,(18) Policy Implications. 6292,h,(a) To fight unemployment, Keynes recommended the policy of deficit spending. But this policy has serious repercussions, because the state may spend beyond its means in an extravagant manner. 6301,h,(b) Keynes's favoured public investment to overcome depression and to attain full employment. 6302,h,(c) Keynes advocated progressive taxation to control inflationary trends in the economy. But higher taxes on companies may discourage private investment, and high commodity taxes may discourage consumption. 6303,h,(d) Keynes paid little attention to monetary policy. In the Keynesian system money in neutral in situations of full employment and liquidity trap (when the rate of interest becomes inelastic in a depression). the Keynesian analysis because monetary policy plays an important role even during these extreme situations, as has been proved by Friedman, Metzler, Patinkin and others. 6312,h,(e) Keynes' policy measures fail to tackle the problems of capital formation and growth which result from technological innovations. 6313,h,(f) Lastly, the Keynesian economics fails to provide solutions to a number of socio-economic problems facing the developed countries. Such problems include fair employment, income distribution and resource allocation. This is a serious weakness in Keynesian policy measures. 6314,4,Conclusion 6315,h,Dillard writes, “Keynes was an original thinker in the sense that he arrived at his ideas in his own way. The ideas he advanced were his own even though some one else may have expounded the 6322,h,Despite Samuelson's severe denunciation of the General Theory as a "badly-written book, poorly organised... not well-suited for classroom use, ... arrogant, bad tempered, polemical, not overly generous in its acknowledgements and abounding in meads and confusions," 6323,h,Keynes's theory of effective demand is the origin of the modern theory of economic policy." And according to Dillard, "The acceptance of deficit financing as a respectable type of public policy is one of the remarkable changes in public thinking for which Keynesian economics has been primarily responsible." 6324,h,General theory was "one of the great intellectual scandals of our age." In fact, Schumpeter's assessment of Malthus applies fairly to Keynes. Keynes "had the good forture— for this is good fortune— to be the subject of equally unreasonable, contradictory appraisals. He was a benefactor of humanity. He was a fiend. He was a profound thinker. He was a dunce. The man whose work stirred people's minds so as to elicit such passionate appraisals was ipso facto no mediocrity." Rather, he was a genius. 6455,2,CHAPTER 23 Applicability of Keynes's Theory To Underdeveloped Countries 6459,3,Keynesian Assumptions and Underdeveloped Countries 6460,h,(1) The Keynesian theory is based on the existence of cyclical un-employment which occurs during a depression. It is caused by deficiency in effective demand. 6468,h,(2) The Keynesian economics is a short period anaylsis in which Keynes takes “as given the existing skill and quantity of available labour, 6475,h,(3) The Keynesian theory is based on the assumption of closed economy. 6476,h,(4) The Keynesian Theory assumes an excess supply of labour and other complementary resources in the economy. 6493,3,The Keynesian Tools and Underdeveloped Countries 6494,5,1. Effective Demand. 6495,h,however, there is no involuntary unemployment but disguised unemployment. 6501,5,2. Propensity to Consume. 6509,5,3. Saving. 6517,5,4. Marginal Efficiency of Capital. 6526,5,5. Rate of Interest. 6533,5,6. The Multiplier. 6542,h,The Keynesian concept of multiplier is based on the following four assumptions: (a) Involuntary unemployment, (b) an industrialized economy where the supply curve of output slopes upward to the right but does not become vertical till after a substantial interval, (c) excess capacity in the consumption goods industries, and (d) comparatively elastc 6550,h,(a) Involuntary unemployment in the Keynesian analysis is associated with a capitalist economy where the majority of workers work for wages 6567,h,(b) The supply curve of output in an underdeveloped country is inelastic which renders the working of the multiplier all the more difficult. 6574,h,(c) Since the marginal propensity to consume is high in underdeveloped countries, the inceased income is spent on self consumption 6583,h,(d) Output is difficult to increase due to the non-availability of sufficient raw materials, capital equipment and skilled labour. 6581,5,Conclusion. The obvious conclusion is that the Keynesian principle of multiplier does not operate in an underdeveloped country like India mainly due to two reasons: firstly, involuntary unemployment of the Keynesian type is not to be found, and secondly, the supply of agricultural and non-agricultural output is inelastic due to the working of certain factors peculiar to such economies. 6592,5,7. Policy Measures. 6627,1,Part-IV Monetary Theory 6628,2,CHAPTER 24 Money 6628,3,Nature and Definition of Money 6628,h,Scitovsky, “Money is a difficult concept to define, partly because it fulfils not one but three functions, each of them providing a criterion of moneyness ... those of a unit of account, a medium of exchange, and a store of value.” 6635,h,Sir John Hicks to say that “money is defined by its functions: anything is money which is used as money: ‘money is what money does.’ 6645,3,Theoretical and Empirical Definitions of Money 6645,5,1. The Traditional Definition of Money. 6661,5,2. Friedman’s Definition of Money. 371 6661: 20150515@ d“the sum of currency plus all adjusted deposits in commercial banks”. 372 6671: 20150515@ d"any asset capable of serving as a temporary abode of purchasing power". 6671,w,abode:a·bode 1 n. FORMAL or POETIC/LITERARY a place of residence; a house or home: her current abode | HUMOROUS my humble abode. - residence: a place of abode. - ARCHAIC a stay; a sojourn. Middle English (in the sense 'act of waiting'): verbal noun from ABIDE. 6637,3,Theoretical and Empirical Definitions of Money 6678,5,3. The Radcliffe Definition. 6678,h,Thus the whole liquidity position is relevant to spending decisions. 6692,5,4. The Gurley-Shaw Definition. 6692,5,5. The Pesek and Saving Definition. 6721,5,Money and Near Money 6731,h,Thus time deposits are not ‘real’ money and for them to become money they must be converted into cash or demand deposits. 6755,h,The tremendous growth of near money assets in the United States is due to the fact that the yield from them is higher than from demand deposits and that they are safer than cash. 6767,h,inside money as money “based on the debt of endogenous economic units”. 6767,h,outside money comes from outside the private sector. It is defined as money “based on the debt of a unit (the government) exogenous to the system.” 6792,3,Neutrality and Non-Neutrality of Money 6804,h,In other words, money is neutral if it does not affect relative prices and leaves the interest rate unaffected. 6804,h,In the classical system, money is neutral in its effect on the economy. It plays no role in the determination of employment, income and output. 6818,h,In the entire Keynesian system, there are two situations in which money is neutral. The first is the situation of full employment when any increase in the quantity of money brings about a proportionate increase in the price level but output remains unchanged at that level. The second is the special case of liquidity trap. When 6834,h,Non-Neutrality of Money. In the Keynesian system so long as there is unemployment, changes in the money supply produce permanent non-neutral effects on the rate of interest, the level of employment, income and output, the rate of capital formation, and so on. 6846,3,Functions of Money 6846,4,1. Primary Functions 6846,5,(i) Money as a Medium of Exchange. 6846,h,This is the primary function of money because it is out of this function that its other functions developed. By 6846,5,(ii) Money as Unit of Value. 6846,h,Money is the standard for measuring value just as the yard or metre is the standard for measuring length. 6880,4,2. Secondary Functions 6880,5,(i) Money as a Standard of Deferred Payments. 6893,5,(ii) Money as a Store of Value. 6905,5,(iii) Money as a Transfer of Value. 6919,4,3. Contingent Functions 6919,5,(i) Money as the Most Liquid of all Liquid Assets. 6919,h,(ii) Basis of the Credit System. 6919,h,(iii) Equaliser of Marginal Utilities and Productivities. 6919,h,The main aim of a consumer is to maximise his satisfaction by spending a given sum of money on various goods which he wants to purchase. 6930,5,(iv) Equaliser of Marginal Productivities. 6930,h,(v) Measurement of National Income. 6930,h,(vi) Distribution of National Income. 6930,4,4. Other Functions 6930,5,(i) Helpful in Making Decisions. 6930,h,(ii) Money as a Basis of Adjustment. 6956,2,CHAPTER 25 Changes in the Value of Money: The Quantity Theory of Money and its Variants 6962,h,Thus in order to measure the value of money, we have to find out the general price level. 6962,3,Fisher's Quantity Theory of Money: The Cash Transactions Approach 6962,h,PT = MV + M' V'
where P = price level, or 1/ P = the value of money;
M = the total quantity of legal tender money;
V = the velocity of circulation of M; M' = the total quantity of credit money;
V' = the velocity of circulation of M';
T = the total amount of goods and services exchanged for money or transactions performed by money. 6998,4,Assumptions of the Theory 7016,4,Criticisms of the Theory 7016,5,1. Truism. 7016,h,According to Keynes, "The quantity theory of money is a truism." 7028,5,2. Other Things not Equal. 7028,h,3. Constants Relate to Different Time. 7046,5,4. Fails to Measure Value of Money. 7046,h,5. Weak Theory. 7046,h,6. Neglects Interest Rate. 7059,5,7. Unrealistic Assumptions. 7059,h,8. V not Constant. 7074,5,9. Neglects Store of Value Function. 7074,h,concentrates on the supply of money and assumes the demand for money to be constant. 7074,5,10. Neglects Real Balance Effect. 7074,h,11. Static. 7074,3,The Cambridge Equations : The Cash Balances Approach 7074,h,money. The demand for money is the demand to hold cash balances for transactions and precautionary motives. 7074,h,the value of money is determined by the demand for cash balances. 7098,5,Marshall's Equation. 7098,h,Thus the price level or the value of money (the reciprocal of price level) is Pigou's Equation. Pigou was the first Cambridge economist to express the cash balances 7119,5,Robertson's Equation. 7119,h,Robertson's Equation. 7140,5,Keynes's Equation. 7155,4,Criticisms of the Cash Balance Approach 7171,5,1. Truisms. 7171,h,2. Price Level does not Measure Purchasing Power. 7171,h,3. More Importance to Total Deposits. 7171,h,4. Neglects other Factors. 7187,5,5. Neglect of Saving-Investment Effect. 7187,h,6. k and Y not Constant. 7187,h,7. Fails to Explain Dynamic Behaviour of Prices. 7187,h,8. Neglects Interest Rate. 7200,h,9. Demand for Money not Interest Inelastic. 7200,h,10. Neglect of Goods Market. 7200,h,11. Neglects Real Balance Effect. 7200,h,12. Elasticity of Demand for Money not Unity. 7200,h,13. Neglects Speculative Demand for Money. 7224,3,Transactions Approach Vs. Cash Balances Approach 7224,4,1. Similarities 7224,5,1. Same Conclusion. 7224,h,2. Similar Equations. 7735,5,3. Money as the Same Phenomenon. 7735,4,2. Dissimilarities 7735,5,1. Functions of Money. 7735,h,2. Flow and Stock. 7735,h,3. V and k Different. 7250,5,4. Nature of Price Level. 7250,h,5. Nature of T. 7250,h,6. Emphasis on Supply and Demand for Money. Fisher's approach emphasises the supply of money, whereas the Cambridge 7250,h,7. Different in Nature. 7250,3,Superiority of Cash Balances Approach over Transactions Approach 7262,5,1. Basis of Liquidity Preference Theory of Interest. 7262,h,2. Complete Theory. 7262,h,3. Discards the Concept of Velocity of Circulation. 7262,h,4. Related to the Short Period. 7262,h,5. Simple Equations. 7262,h,6. New Formulation in Monetary Theory. 7262,h,7. Explains Trade Cycles. 7289,5,8. Study of Subjective Factors. 7289,h,9. Applicable under All Circumstances. 7289,h,10. Based on Micro Factors. 7304,2,CHAPTER 26 The Keynesian Theory of Money and Prices 7323,3,Keynes's Reformulated Quantity Theory of Money 7323,h,This theory is based on the following assumptions:

    1. All factors of production are in perfectly elastic supply so long as there is any unemployment.
    2. All unemployed factors are homogeneous, perfectly divisible and interchangeable.
    3. There are constant returns to scale so that prices do not rise or fall as output increases.
    4. Effective demand and quantity of money change in the same proportion so long as there are any unemployed resources. 7332,h,the Keynesian chain of causation between changes in the quantity of money and in prices is an indirect one through the rate of interest. 7344,h,The Complicated Model. Keynes himself pointed out that the real world is so complicated that the simplifying assumptions upon which the reformulated quantity theory of money is based, will not hold. 7359,h,(1) "Effective demand will not change in exact proportion to the quantity of money.
    (2) Since resources are homogenous, there will be diminishing, and not constant returns as employment gradually increases.
    (3) Since resources are not interchangeable, some commodities will reach a condition of inelastic supply while there are still unemployed resources available for the production of other commodities.
    (4) The wage-unit will tend to rise, before full employment has been reached.
    (5) The remunerations of factors entering into marginal cost will not all change in the same proportion." 7404,3,Superiority of the Keynesian Theory Over the Traditional Quantity Theory of Money 7416,h,Thus the Keynesian analysis is superior to the traditional analysis because it studies the relationship between quantity of money and prices both under unemployment and full employment situations. 7416,3,Criticisms of Keynes' Theory of Money and Prices 7427,5,1. Direct Relation. 7427,h,2. Stable Demand for Money. 7427,h,3. Nature of Money. 7427,h,4. Effect of Money. 7427,h,It was, therefore, wrong on the part of Keynes to argue that money had little effect on income. Money does affect national income. 7442,2,CHAPTER 27 Friedman's Restatement of the Quantity Theory of Money 7475,h,Forms of Wealth. 7475,5,1. Money 7475,h,2. Bonds 7475,h,3. Equities 7475,h,4. Physical goods or non-human goods 7475,h,5. Human capital 7547,4,Its Criticisms 7547,5,1. Very Broad Definition of Money. 7547,h,Friedman has been criticised for using the broad definition of money 7560,5,2. Money not a Luxury Good. 7560,h,3. More Importance to Wealth Variables. 7560,h,4. Money Supply not Exogenous. 7573,5,5. Ignores the Effect of Other Variables on Money Supply. 7573,h,6. Does not consider Time Factor. 7573,h,7. No Positive Correlation between Money Supply and Money GNP. 7573,5,Conclusion. 7586,3,Friedman Vs Keynes 7586,h,First, Friedman uses a broader definition of money than that of Keynes in order to explain his demand for money function. 7586,h,Second, Friedman postulates a demand for money function quite different from that of Keynes. 7586,h,Third, there is also the difference between the monetary mechanisms 7600,h,Fourth, there is the difference between the two approaches with regard to the motives for holding money balances. Keynes 7600,h,Fifth, in his analysis, Friedman introduces permanent income 7617,2,CHAPTER 28 The Supply of Money 7617,3,Definitions of Money Supply 7654,3,Determinants of Money Supply 7668,4,1. The Required Reserve Ratio 7668,h,is an important determinant of the money supply. 7680,4,2. The Level of Bank Reserves 7680,h,central bank requires all commercial banks to hold reserves equal to a fixed percentage of both time and demand deposits. These are legal minimum or required reserves. 7680,h,A commercial bank advances loans equal to its excess reserves which are an important component of the money supply. To determine the supply of money with a commercial bank, the central bank influences its reserves by adopting open market operations and discount rate policy. 7706,4,3. Public's Desire to Hold Currency and Deposits 7706,h,4. High-Powered Money 7706,h,5. Other Factors 7715,4,Conclusion. 7715,h,(a) The marginal propensity to save 7715,h,(b) Banks may also create more or less credit 7715,h,(c) The velocity of circulation of money also affects 7727,3,High-Powered Money and the Money Multiplier 7727,h,The use of high-powered money consists of the demand of commercial banks for the legal limit or required reserves 7739,h,High-powered money (H) (or monetary base) consists of currency held by the public (C) plus required reserves (RR) and excess reserves (ER) of commercial banks. Thus high-powered money The relation between M and H can be expressed as the ratio 7789,h,But the monetarists give more importance to excess reserves. According to them, due to uncertainties prevailing in banking operations as in business, banks always keep excess reserves. The amount of excess reserves depends upon the interaction of two types of costs: the cost of holding excess reserves, and the cost generated by deficiency in excess reserves. 7805,3,Measures of Money Supply in India 7834,h,RBI calls M3 as broad money. M4. The fourth measure of money supply is M4 which consists of M3 plus total post office deposits comprising time deposits and demand deposits as well. This is the broadest measure of money supply. 7852,3,Money Supply and Liquidity 437 7853: 20150515@ A liquid asset is one which is easily spendableand transferable at face value anywhere and at any time. 7893,h,But how does a change in money supply affect liquidity ? A 7907,h,monetary authority that influences money supply in the economy by following "easy" or "tight" monetary policy. 7907,3,Derivation of Money Multipliers 7972,2,CHAPTER 29 Credit Creation By Commercial Banks 7972,3,DO BANKS CREATE CREDIT? 7992,h,This view is also wrong becuase it is based on arguments relating to a single bank. As pointed out by Prof Samuelson, "The banking system as a whole can do what each small bank cannot do: it can expand its loans and investments many times the new reserves of cash created for it, even though each small bank is lending out only a fraction of its deposits." 8017,3,The Process of Credit Creation 8028,h,where 1/ RRr, the reciprocal of the percentage reserve ratio, is called the deposit (or credit) expansion multiplier. 8073,2,Limitations on The Power of Banks to Create Credit 8083,5,1. Amount of Cash. 8083,h,2. Proper securities. 8083,h,3. Banking habits of the People. 8083,h,will lead to the withdrawal of cash from the credit creation stream of the banking system. This reduces the power of banks to create credit to the desired level. 8095,5,4. Minimum Legal Reserve Ratio. 8095,h,5. Excess Reserves. 8095,h,6. Leakages. 8095,h,7. Cheque Clearances. 8108,5,8. Behaviour of other Banks. 8108,h,9. Economic Climate. 8108,h,10. Credit Control Policy of the Central Bank. 8120,h,We may conclude that commercial banks do not possess unlimited powers to create credit. 8124,2,CHAPTER 30 Central Banking: Functions And Credit Contraol 8124,3,Definition of a Central Bank 453 8130: 20150515@ hgx:"The primary definition of central banking is a banking system in which a single bank has either complete control or a residuary monopoly of note issue." 8130,h,central bank is that which is the lender of the last resort. 8143,3,Functions Of A Central Bank 8143,4,1. Regulator of Currency 8153,h,The central bank can restrict or expand the supply of cash according to the requirements of the economy. Thus it provides elasticity to the monetary system. By having a monopoly of note issue, the central bank also controls the banking system by being the ultimate source of cash. Last but not the least, by entrusting the monopoly of note issue to the central bank, the government is able to earn profits from printing notes whose cost is very low as compared with their face value. 8154,4,2. Banker, Fiscal Agent and Adviser to the Governement 8165,h,Thus it is the custodian of government money and wealth. As 8165,4,3. Custodian of Cash Reserves of Commercial Banks 8165,h,Commercial banks are required by law to keep reserves equal to a certain percentage of both time and demand desposits liabilities with the central bank. It is on the basis of these reserves that the central bank transfers funds from one bank to another to facilitate the clearing of cheques. 8178,4,4. Custody and Management of Foreign Exchange Reserves 8178,h,manages exchange control operations by supplying foreign currencies to importers and persons visiting foreign countries on business, studies, etc. in keeping with the rules laid down by the government. 8178,4,5. Lender of the Last Resort 8190,4,6. Clearing House for Transfer and Settlement 8202,4,7. Controller of Credit 8202,h,The most important function of the central bank is to control the credit creation power of commercial bank in order to control inflationary and deflationary pressures within the economy. 8202,4,8. Other Functions 8214,3,Central Bank as The Controller of Credit 8214,4,Objectives of Credit Control 8214,5,1. To Stabilise the Internal Price Level. 8238,5,5. To Meet Business Needs. 8238,h,6. To Have Growth with Stability. 8238,4,Methods of Credit Control 8238,h,Quantitative Methods. 8250,4,1. Bank Rate or Discount Rate Policy 8250,h,Limitations of Bank Rate Policy 8250,5,1. Market Rates do not change with Bank Rate. 8250,h,2. Wages, Costs and Prices not Elastic. 8250,h,3. Banks do not approach Central Bank. 8250,h,4. Bills of Exchange not Used. 8273,5,5. Pessimism or Optimism. 8273,h,6. Power to Control Deflation Limited. 8273,h,7. Level of Bank Rate in relation to Market Rate. 8273,h,8. Non-Discriminatory. 8273,h,9. Not Successful in Controlling BOP Disequilibrium. 8273,4,2. Open Market Operations 8310,h,Thus open market operations have a direct influence on the market rates of interest also. Limitations of Open 8310,4,Limitations of Open Market Operations 8322,5,1. Lack of Securities Market. 8322,h,2. Cash Reserve Ratio not Stable. 8322,h,3. Penal Bank Rate. 8334,5,4. Banks Act Differently. 8334,h,5. Pessimistic or Optimistic Attitude. 8334,h,6. Velocity of Credit Money not Constant. 8346,5,Conclusion. 8346,4,Open Market Operations vs Bank Rate Policy 8358,5,Conclusion. 8370,4,3. Variable Reserve Ratio 8382,4,Limitations of Variable Reserve Ratio 8382,5,1. Excess Reserves. 8382,5,2. Clumsy Method. 8394,5,3. Discriminatory. 8394,h,4. Inflexible. 8394,5,6. Stability of Reserve Ratio. 8394,h,7. Other Factors. 8394,h,8. Depressive Effect. 8394,h,9. Rigid. 8394,h,10. Not for Small Changes. 8419,5,Conclusion. 8419,4,Variable Reserve Ratio vs Open Market Operations 8454,4,Selective Credit Controls or Qualitative Methods 8466,4,(A) Regulation of Margin Requirements 8488,4,(B) Regulation of Consumer Credit 8511,4,(C) Rationing of Credit 8523,4,(D) Direct Action 8523,h,"directives" issued from time to time to the commercial banks to follow a particular policy which the central bank wants to enforce immediately. 8534,4,(E) Moral Suasion 8545,4,(F) Publicity 8556,4,Limitations of Selective Credit Controls 8556,5,1. Limited Coverage. 8556,h,2. No Specificity. 8556,h,3. Difficult to distinguish between Essential and Non-essential Factors. 8568,5,4. Require Large Staff. 8568,h,5. Discriminatory. 8568,h,6. Malallocation of Resources. 8568,h,7. Not Successful in Unit Banking. 8579,4,Conclusion. 8588,2,CHAPTER 31 The Monetarist Revolution 8588,h,The “monetarist revolution” refers to the new and important contributions made to monetary theory and policy by Prof. Friedman and his colleagues at the University of Chicago. It was a sort of revolution against the views of Keynesians who held the view that “money does not matter.” 8588,h,monetarist revolution “only money matters” for three reasons: one, because the quantity of money is capable of being controlled fairly accurately by deliberate policy; two, because changes in the quantity of money can produce substantial changes in the flow of income, prices and other important variables; and three, because the relationships between stock of money and other assets are relatively stable and dependable.” 8595,3,Main Features 8595,4,1. Money Supply Crucial Determinant 8595,h,That link is the constant velocity of money. 8607,h,Thus there will be inflation due to inappropriate increase in money supply. That is why the monetarists regard inflation as a purely monetary phenomenon. 8619,4,2. Transmission Mechanism of Monetary Influences 8632,4,3. Deteminant of Real National Income 8632,h,Thus the economy is usually at or near the full employment level where there is no involuntary unemployment. Friedman refers to this as the natural rate of unemployment. This view is in marked contrast to the Keynesian view that there is always underemployment equilibrium in the economy and unemployment is involuntary. 8632,4,4. Stable Economy 8643,4,5. Important Role of Expectations 8655,h,For example, the rational expectationists deny the possibility of any inflation-unemployment trade-off even in the short run. Economists regard the above views of the monetarists as revolutionary. 1 8655,4,Criticisms 8655,h,1. Money Supply Endogenous 8655,h,2. Demand for Money not Stable 8655,h,3. Money Supply and GNP not Positively Correlated 8679,4,4. Neglects the Role of NBFIs 8679,h,5. Real World does not Approximate to a General Equilibrium System 8679,h,6. Economy not Inherently Stable 8689,4,7. Money Supply fails to grow at a Smooth and Steady Rate 8702,2,CHAPTER 32 The Demand For Money 8709,3,The Classical Approach 8709,h,In Fisher's "Equation of Exchnage", MV = PT 8721,h,But people also hold money for other reasons, such as to earn interest and to provide against unforeseen events. 8733,h,The Cambridge demand equation for money is Md = kPY 8733,4,Its Critical Evaluation 8733,3,The Keynesian Approach : Liquidity Preference 8733,h,demand for money in an economy:( 1) the transactions demand, (2) the precautionary demand, and (3) the speculative demand. 8733,4,The Transactions Demand for Money 8757,h,transactions demand for money is a direct proportional and positive function of the level of income, and is expressed as
    LT = kY 8769,5,Interest Rate and Transactions Demand. 8817,h,function of both income and interest rates which can be expressed as LT = f (Y, r). 8833,4,The Precautionary Demand for Money 8892,h,But at a very low rate of interest r2, the LS curve becomes perfectly elastic. This is know as the liquidity trap when people prefer to keep money in cash rather than invest in bonds and the speculative demand for money is infinitely elastic. 8892,h,Thus the Keynesian speculative demand for money function is highly volatile, depending upon the behaviour of interest rates. 8909,4,Note on Liquidity Trap 8909,h,balances. This is the famous Keynesian liquidity trap. In this case, changes in the quantity of money have no effects at all on prices or income. ,,At a very low rate of interest, such as r2, in Figure 5, the Ls curve becomes perfectly elastic and the speculative demand for money is infinitely elastic. This portion of the Ls curve is known as the liquidity trap. 8923,h,Further, according to Keynes, "a long-term rate of interest of 2 per cent leaves more to fear than to hope, and offers, at the same time, a running yield which is only sufficient to offset a very small measure of fear." 8923,5,Its Implications. 8923,h,First, the monetary authority cannot influence the rate of interest even by following a cheap money policy. 497 8937: 20150515@ Secondthe rate of interest cannot fall to zero. 8937,h,Third, the policy of a general wage cut cannot be efficacious in the face of a perfectly elastic liquidity preference curve, 8937,4,The Total Demand for Money 8937,h,LT = f (Y), 8958,h,lateral summation of LT and LS curves : L = LT + LS. 8958,3,The Post-Keynesian Approaches 8958,4,1. Baumol's Inventory Theoretic Approach13 8976,4,Its Assumptions Baumol's theory is based on the following assumptions:
    1. The transactions between money and bonds are transparent and occur in a steady stream.
    2. The bond market is perfect where there is easy conversion of bonds into cash and vice versa.
    3. There is a fixed cost in exchanging bonds for cash and vice versa.
    4. The holding of cash involves interest cost and non-interest costs.
    5. The interest cost (or rate of interest) is constant over the year.
    6. The non-interest costs such as brokerage fee, mailing expenses, etc. are also fixed over the year.
    9061,4,Its Superiority over the Classical and Keynesian Approaches 9061,h,Baumol's inventory theoretic approach to the transactions demand for money is an improvement over the classical and Keynesian approaches. 9061,h,1. The cash balances quantity theory of money assumed the relationship between the transactions demand and the level of income as linear and proportional. Baumol has shown that this relationship is not accurate. 9061,h,2. Baumol's theory also has the merit of demonstrating the interest elasticity of the transactions demand for money as against the Keynesian view that it is interest inelastic. 9061,h,3. Baumol analyses the transactions demand for real balances thereby emphasising the absence of money illusion. 9061,h,4. Baumol's inventory theoretic approach is superior to both the classical and Keynesian approaches because it integrates the transactions demand for money with the capital-theory approach by taking assets and their interest and non-interest costs into account. 9061,h,5. Baumol's theory removes the dichotomy between transactions and speculative demand for money of the Keynesian approach. 9061,4,2. Tobin's Portfolio Selection Model: The Risk Aversion Theory of Liquidity Preference 9061,h,James Tobin in his famous article "Liquidity Preference as Behaviour Towards Risk," 14 formulated the risk aversion theory of liquidity preference based on portfolio selection. 9086,h,But the majority of investors belong to the third category. They are risk averters or diversifiers. 9155,4,Its Superiority over Keynesian Theory 9155,h,First, Tobin's theory does not depend on inelasticity of expectations of future interest rates, but proceeds from the assumption that the expected value of capital gain or loss from holding interest-bearing assets is always zero. 9155,h,Second, this theory is superior to Keynes's theory in that it explains that individuals hold diversified portfolios of bonds and money rather than either bonds or money. 9155,h,Third, like Keynes, Tobin regards the demand for money as closely dependent on interest rates and inversely related to interest rates and his theory provides a basis for liquidity preference. 9167,h,Fourth, Tobin is more realistic than Keynes in not discussing the perfect elasticity of demand for money (the liquidity trap) at very low rates of interest. 9167,h,Fifth, according to David Laidler, the real importance of the portfolio theory lies in "not what it tells directly about the aggregate economy, 9177,2,CHAPTER 33 THEORIES OF INTEREST RATE 9177,h,theories of interest rate such as the classical, the loanable funds, the Keynesian, and the modern 9177,h,Keynesian liquidity preference theory that determines the interest rate by the demand for and supply of money is a stock theory. It emphasises that the rate of interest is a purely monetary phenomenon. 9184,3,The Classical Theory of Interest 9196,h,marginal productivity of capital to him. It shows that at a higher rate of interest, the demand for capital is low and it is high at a lower rate of interest. Thus the demand for capital is inversely related to the rate of interest, 9196,h,saving involves a sacrifice, abstinence or waiting when they forgo present consumption in order 9224,5,(1) Income not Constant but Variable. 9224,h,(2) Saving-Investment Schedules not Independent. 9224,h,(3) Neglects the Effects of Investment on Income. 9237,h,But Keynes does not believe that investment depends on the rate of interest. It depends on the marginal efficiency of capital. 9237,5,(4) Indeterminate Theory. 9237,h,So, for each income level a separate saving curve will have to be drawn. This is all circular reasoning and offers no solution to the problem of interest. That is why Keynes characterised the classical theory of interest as indeterminate. (5) Neglects other 9237,5,(5) Neglects other Sources of Savings. 9249,h,(6) Unrealistic Assumption of Full Employment. 9249,h,(7} Neglects Monetary Factors. 9249,h,(8) No Automatic Equality between Equilibrium and Market Rates of Interest. 9260,5,(9) Difference over the Definition of Interest. 9260,h,Thus, Keynes dismisses the classical theory of interest as absolutely wrong and inadequate. 9260,3,The Loanable Funds Theory of Interest 9272,5,Demand for Loanable Funds. 9297,5,(1) Equilibrium Rate reflects Unstable Equilibrium. 9297,h,(2) Indeterminate Theory. 9312,5,(3) Cash Balances not Elastic. 9312,h,(4) Savings not Interest Elastic. 9312,h,(5) Not correct to combine Real and Monetary Factors. 9312,4,Its Superiority over the Classical Theory 9312,h,Despite these weaknesses, the loanable funds theory is better and more realistic than the classical theory on a number of counts. 9324,3,Keynes's Liquidity Preference Theory of Interest 9334,h,demand for resources to invest with the readiness to abstain from consumption. 9334,h,The rate of interest, in Keynes words, is the "premium which has to be offered to induce people to hold the wealth in some form other than hoarded money." 9347,h,According to Keynes, there are three motives behind the desire of the people to hold liquid cash: (1) the transaction motive, (2) the precautionary motive, and (3) the speculative motive. 9347,h,Transactions Motive. The transactions motive relates to "the need of cash for the current transactions of personal and business exchanges." 9347,h,Precautionary Motive. The precautionary motive relates to "the desire to provide for contingencies requiring sudden expenditures and for unforeseen opportunities of advantageous purchases." 9361,h,Keynes holds that the transactions and precautionary motives are relatively interest inelastic, but are highly income elastic. 9361,h,A bond carries a fixed rate of interest. For instance, if a bond of the value of Rs 100 carries 4% interest and the market rate of interest rises to 8%, the value of this bond falls to Rs 50 in the market. If the market rate of interest falls to 2%, the 9361,h,the liquidity trap. At a very low rate of interest, people prefer to keep money in cash rather than invest in bonds because purchasing bonds will mean a definite loss. 9386,5,Determination of the Rate of Interest. 9423,5,(1) College Bursar's Theory. 9436,5,(2) Inadequate and Misleading Theory. 9436,h,(3) Falls into Methodological Fallacy. 9436,h,Thus the Keynesian theory falls into "methodological fallacy" by assuming a definite functional relationship between the quantity of money and the rate of interest. 9436,5,(4) Money as a Store of Wealth is Barren. 9436,h,(5) Inconsistent Theory. 9461,5,(6) Saving Essential for Liquidity. 9461,h,"Without saving there can be no liquidity to surrender. The rate of interest is the return for saving without liquidity." 9461,5,(7) Liquidity not Essential for Interest Rate. 9461,h,(8) Wrong Notion of Liquidity Trap. 9461,h,(9) Ignores Real Factors. The greatest fallacy in Keynes's analysis is that he ignores the influence of real factors in determining the interest rate. 9474,5,(10) Indeterminate Theory. 9474,h,(11) Incomplete Theory. 9488,5,(12) Confusion regarding Relation between Interest Rate and Quantity of Money. 9488,h,It treats the interest rate as a purely monetary phenomenon and by neglecting the real factors makes the theory narrow and unrealistic. 9488,4,Its Superiority over the Loanable Funds Theory 9488,5,(1) The Keynesian theory is a stock analysis. 9488,h,(2) The liquidity preference theory is more realistic than the loanable funds theory because it is more akin to the behaviour of interest rate in the business world. 9512,3,Indeterminacy of the Classical, The Loanable Funds and The Keynesian Theories of Interest 9512,h,Hence the classical and the loanable funds theories of interest rate are indeterminate. 9512,h,perfectly inelastic money supply curve QM is drawn on the assumption that the supply of money is fixed by the monetary authority. 9512,h,the Kenesian theory simply relates different income levels to various interest rates, but does not show what the rate of interest will be. Hence it is an indeterminate theory. 9512,4,Modern Theory of Interest 9512,h,The IS Curve 9579,4,The LM Curve 9612,h,fall. This lower limit to which the rate of interest will fall is the Keynesian liquidity trap already explained above in Keynes's theory of interest. 9612,4,Determination of the Rate of Interest 9642,h,Thus with a given LM curve, when the IS curve shifts to the right income increases and along with it the rate of interest also rises. Given the IS curve, when the LM curve shifts to the right, income increases but the rate of interest falls. The Hicks-Hansen analysis is thus an integrated and determinate theory of interest in which the two determinates, the IS and LM curves, based on productivity, thrift, liquidity preference and the supply of money, all play their parts in the determination of the rate of interest. 9656,4,Its Criticisms 9656,5,1. Static Theory. 9656,h,2. Interest Rate not Flexible. 9656,h,3. Investment not Interest Elastic. 9656,h,4. Highly Artificial. 9656,h,5. Closed Model. 9668,h,6. Price Level Exogenous Variable. 9668,3,Natural and Market Rate of Interest 9668,4,The Wicksell Theory 9679,h,The Wicksell theory is based on. the following assumptions:
    1. There is full employment in the economy.
    2. Investment is a decreasing function of the rate of interest.
    3. Saving is an increasing function of the rate of interest. 9679,h,depends on the expected profitability of new investment. All factors which affect the expected profitability of investment bring changes in the natural rate of interest. 9715,4,A Critical Appraisal 9742,h,Mrs Robinson regards the Wicksell Effect as "the key to the whole theory of capital accumulation." 9756,4,Fisher's Analysis 9798,,b,0150811 9799,2,CHAPTER 34 Term Structure of Interest Rates 9806,3,Factors Determining the Term Structure of Interest Rates 9806,5,1. Risk Preference. 9818,5,2. Supply-Demand Conditions. 9818,h,3. Expectations and Uncertainty. Other 9830,3,Theories of Term Structure of Interest Rates 9830,4,The Expectations Theory 9830,h,Its Assumptions 9830,5,1. All investors have definite expectations 9841,5,2. The objective of investors is to maximise expected profits, 9841,4,Explanation 9882,5,Its Policy Implications. 9901,4,Its Criticisms 9912,4,The Segmented Markets Theory 9923,4,Its Assumptions 9923,h,The Theory 9946,4,Its Policy Implications 9958,4,Its Criticisms 9981,4,Its Superiority Over Expectations Theory 9981,5,1. The segmented market theory is superior to the expectations theory because it does not assume the unrealistic assumption of the expectations theory that short-term and long-term securities are perfect 9991,5,2. The segmented market theory is also superior to the expectations theory because it rejects the assumption of the latter that the future interest rates are known with certainty. 9991,h,3. Another reason of the superiority of segmented market theory over the expectations theory is that it does not explain the term structure of interest rates on the basis of the average of expected short-term interest rates. 9991,h,4. As against the expectations theory, the segmented market theory does not explain a unique relation between short-term and long-term interest rates. 10004,5,5. The segmented market theory is also superior to the expectations theory because it is supported by institutional practices. 10004,4,The Substitutability Theory 10015,4,The Keynesian Theory 10028,4,The Liquidity or Risk Premium Theory 10087,4,The Preferred Habitat Theory 10154,2,CHAPTER 35 The Real Balance Effect and Pigou Effect 10154,3,Patinkin's Integration of Monetary Theory and Value Theory : The Real Balance Effect 10154,h,Don Patinkin in his monumental work Money, Interest and Prices 10160,h,prices will have no effect on the demand and supply of goods. 10172,h,With sufficiently large fall in wages and prices, the full employment level of output and income will be restored. Finally, even if there is the “liquidity trap”, the expansion of the money supply will increase money balances, and full employment can be restored through the operation of the real balanace effect. 10230,3,The Pigou Effect 10230,h,The Pigou effect, also known as the wealth effect, was propounded by A.C. Pigou in 1943 to counter Keynes' argument that wage-price deflation cannot lead to automatic full employment. 10328,3,Differences Between Pigou Effect and Real Balance Effect 10353,2,CHAPTER 36 Wage-Price Flexibility and Full Employment 10353,h,Keynes was against wage-cutting and argued for increase in effective demand to remove unemployment. In this chapter, we discuss in detail the classical and Keynesian views on the relationship between wages and employment. 10353,3,The Classical View 10358,h,In a competitive economy when money wages are reduced, they lead to reduction in cost of production and consequently to the lower prices of products. When prices fall, demand for products will increase and sales will be pushed up. Increased sales will necessitate the employment of more labour and ultimately full employment will be attained. 10403,4,Keynes’s Criticisms of the Classical View 10403,h,Keynes did not accept the classical view that reduction in money wages led to full employment. He emphasised that unemployment could be removed by raising effective demand. His main objections to the classical view were as follows: 10403,5,1. Not Applicable to Economy. 10423,h,Keynes, when money wages are reduced in the economy, they will reduce money incomes of the workers who will reduce their demand for products. 10423,h,Thus the main defect in the classical view was the failure to recognise the dual nature of wages as costs and incomes. The classicists only considered the cost aspect and neglected the income aspect. 10423,5,2. No Need for Cut in Money Wages. 10423,h,3. Inverse Relation between Money and Real Wages. 10423,h,This is because a fall in money wages will lead to a more than proportionate fall in prices. 10423,h,relation between money wage and real wage, falls down and it is not possible to achieve full employment by reduction in money wages. 10435,5,4. Decline in Outlay, Demand and Prices. 10435,h,5. Cut in Real Wages via Increase in Prices. 10435,h,6. Cut in Money Wages Impractical. 10448,5,7. Social Justice. 10448,4,The Keynesian View 10448,h,According to .Keynes, unemployment resulted from the lack of aggregate demand. It is demand that determines employment, and employment determines the real wage rate, not the other way round. 10448,h,In order to establish this, Keynes brought out the distinction between money wages and real wages. Keynes pointed out that the relation between the two is inverse. 10460,h,Keynes argued that workers are prepared to work at the current money wage rate, even if their real wage rates are lowered by increase in prices. This is because of the existence of “money illusion” in the labour market. 10490,h,The main difference between the classical and Keynesian propositions about cut in real wages lies in that the classicists advocated cut in real wages through cut in money wages. They believed in the flexibility of money wages. 10490,h,Keynes believed that money wages are not flexible, rather they are sticky downward. 10490,4,Keynesian Views on Money-Wage Reductions and Employment 10504,5,Wage Cut and Propensity to Consume. 10504,h,The rich, on the other hand, have a high propensity to save and a low propensity to consume. This causes a decline in aggregate demand, income and employment. This is called Keynes's redistributive effect. 10516,h,hThe owners of these fixed assets will feel themselves richer than before and their propensity to consume will be strengthened and the propensity to save weakened. This is known as the Pigou Effect which will tend to increase aggregate demand and employment. 10516,5,Wage Cut and the MEC. 10529,h,No entrepreneur will be prepared to invest under such conditions. 10542,5,Wage Cut and the Interest Rate. 10542,h,Thus more money will be available for speculative motive and the rate of interest would fall. 10542,h,This process of increase in investment and employment via reduction in wages and rate of interest is called the “Keynes Effect.” 10556,3,The Keynes Effect* 10556,h,The process of increase in investment and employment via reduction in money wages and interest rate is called the Keynes effect. 10567,h,But Keynes did not believe that a policy of flexible wages and prices can lead to full employment. It can only lead to underemployment equilibrium. 10595,h,IS curve cuts the LM2 curve in the liquidity trap. 10595,4,Its Criticisms 10595,h,The Keynes effect has been criticised by Hansen, Patinkin and other economists on the following grounds: 10595,5,1. Ignores other Factors. 10611,5,(a) Real Balance Effect. 10611,h,(b) Money Illusion. 10611,h,(c) Price Level Expectations. 10623,5,2. Liquidity Trap an Extreme Case. 10623,h,3. Investment not Insensitive to Interest Rate. 10623,h,4. Adverse Effects of Wage-Price Deflation. 10635,5,5. Wage-Price Deflation a Theoretical Possibility. 10635,h,6. Wage-Price Deflationary Process Absurd. 10635,3,Flexible Wage Policy vs Flexible Monetary Policy 10658,h,Again, a gereral cut in money wages is bound to adversely affect the MEC, investment and employment in the economy. 10658,h,Keynes did not favour a flexible wage policy in the form of a cut in money wages on certain practical grounds also. 10658,h,Further, social justice requires that money wages of worker alone should not be cut. 19671,h,According to Keynes, "The economic system cannot be made self-adjusting along these lines." 19671,h,In other words, a policy of increasing the supply of money can lead to increase in employment by lowering the interest rate, like the policy of a cut in money wages. Such a policy is not only realistic but also involves far less social costs. 10683,h,"Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter." 10693,,b,0150618 10696,1,Part-V Inflation and Business Cycles 10697,2,CHAPTER 37 Inflation and Deflation 10697,h,Keynes in his General Theory allayed all such fears. He did not believe like the neo-classicists that there was always full employment in the economy which resulted in hyper-inflation with increases in the quantity of money. 10697,w,bottleneck inflation or “semi-inflation”. If 10717,3,Meaning of Inflation 596 10717: 20150618@ hgx:the words of Friedman, “Inflation is always and everywhere a monetary phenomenon... and can be produced only by a more rapid increase in the quantity of money than output.” 3 10730,5,1. Creeping Inflation. 10730,h,creeper, it is called creeping inflation. In terms of speed, a sustained rise in prices of annual increase of less than 3 per cent per annum is characterised as creeping inflation. Such an increase in prices is regarded safe and essential for economic growth. 10747,5,2. Walking or Trotting Inflation. 10747,h,3. Running Inflation. 10747,h,4. Hyperinflation. 10747,w,runaway or galloping inflation. 10757,3,The Inflationary Gap 10757,h,inflationary gap as an excess of planned expenditure over the available output at pre-inflation or base prices. 10819,h,goods market as well as in the factor market. 10846,3,Demand-Pull or Monetary Theories of Inflation 10846,h,takes place when aggregate demand is rising while the available supply of goods is becoming less. 10846,h,“too much money chasing too few goods.” 10846,4,1. Monetarist View or Monetary Theory of Inflation 10846,h,Consequently, the amount of money spent did not affect the level of real output so that a doubling of the quantity of money would result simply in doubling the price level. Until prices had risen by this proportion, individuals and firms would have excess cash which they would spend, leading to rise in prices. 10872,4,Friedman’s View 10872,h,“inflation is always and everywhere a monetary phenomenon that arises from a more rapid expansion in the quantity of money than in total output.” 10912,4,2. Keynes’ Theory of Demand-Pull Inflation 10912,h,Keynes and his followers emphasise the incease in aggregate demand as the source of demand-pull inflation. 10912,h,Thus the aggregate demand comprises consumption, investment and government expenditures. When the value of aggregate demand exceeds the value of aggregate supply at the full employment level, the inflationary gap arises. 10920,h,The supply of some factors might become inelastic or others might be in short supply and non-substitutable. This would lead to increase in marginal costs and hence in prices. 10946,4,3. Bent Hansen’s Excess Demand Model 11033,4,Cost-Push Inflation 11033,h,Cost-push inflation is caused by wage increases enforced by unions and profit increases by employers. 11033,h,The basic cause of cost-push inflation is the rise in money wages more rapidly than the productivity of labour. In advanced countries, trade unions are very powerful. 11046,h,Cost-push inflation may be further aggravated by upward adjustment of wages to compensate for rise in the cost of living index. 11046,w,proft-push inflation. Oligopolist and monopolist firms raise the prices 11058,w,administered-price theory of inflation or price-push inflation or sellers’ inflation or market-power inflation. 11065,h,impact on prices. Economists, therefore, do not give much importance to profit-push inflation as an explanation of cost-push 11093,h,The cost-push theory has been criticised on three issues. 11093,3,Demand-Pull Versus Cost-Push Inflation 11093,h,debate between demand-pull and cost-push inflation arises mainly from the difference between the policy recommendations on the two views. Recommendations on demand-pull inflation are related to monetary and fiscal measures which lead to a higher level of unemployment. 11118,h,“The trouble is that we have no normal initial standard from which to measure, no price level which has always existed to which every one has adjusted.” 11118,h,If prices increase first, it is a demand-pull inflation, and if wages increase follow, it is a cost-push inflation. 11131,3,We may conclude with Lipsey :“ Debate continues on the balance between demand and cost as forces causing inflation in the contermporary inflationary climate. The debate is important because the policy implications of different causes of inflation are different, and different target variables need to be controlled, according to the cause. Until the causes of inflation are fully understood, there will be debate about policies.” 11131,h,elements of both. 11143,h,Suppose an inflationary process begins with excess demand with no cost-push forces at work. Excess demand will raise prices which will in due course pull up money wages. But the rise in money wages is not the result of cost-push forces. Such a mixed inflation will lead to sustained rise in prices. 11179,h,The cost-push inflationary process will be self-sustaining only if every wage-push is accompanied by a corresponding increase in aggregate demand. 11179,3,Sectoral or Demand-shift Inflation 11233,3,Structural Inflation 11245,h,first the prices of agricultural goods, second, the general price level, and third, wages. Let us analyse them. 11245,5,1. Agricultural Goods. 11245,h,2. Wage Increases. 11258,5,3. Import Substitution. 11278,5,4. Tax System. 11278,h,5. Money Supply. 11291,3,Markup Inflation 11301,h,The analysis is based on the assumption that both wages and prices are “administered” 11325,3,Open and Suppressed Inflation 11325,h,Inflation is open when “markets for goods or factors of production are allowed to function freely, setting prices of goods and factors without normal interference by the authorities.” 11336,5,Suppressed Inflation. 11349,3,The Phillips Curve : The Relation between Unemployment and Inflation 11349,h,The Phillips curve examines the relationship between the rate of unemployment and the rate of money wage changes. 11397,,b,0150620 11411,h,But there are certain variables which cause the Phillips curve to shift over time and the most important of them is the expected rate of inflation. So long as there is discrepancy between the expected rate and the actual rate of inflation, 11411,w,natural rate of unemployment. 11411,h,expected rate of inflation. 11421,h,Rather, it is determined by a number of structural characteristics of the labour and commodity markets within the economy. These may 11421,h,imperfections.But what causes the Phillips curve to shift over time is the expected rate of inflation. This refers to the extent the labour correctly 11449,h,In the long-run, the economy is bound to establish at the natural unemployment rate. 11449,h,There is, therefore, no trade-off between unemployment and inflation except in the short run. 11475,4,Tobin’s View 11496,4,Solow’s View 11496,h,Conclusion. The vertical Phillips curve has been accepted by the majority of economists. They agree that at unemployment rate of about 4 per cent, the Phillips curve becomes vertical and the trade-off between unemployment and inflation disappears. It is impossible to reduce unemployment below this level because of market imperfections. 11506,3,Rational Expectations and Long-Run Phillips Curve 11531,3,Policy Implications of the Phillips Curve 11544,h,levels of unemployment. In other words, it provides a guideline to the authorities about the rate of inflation which can be tolerated with a given level of unemployment. For this purpose, 11605,3,Stagflation 11605,w,inflationary recession. 11641,4,Measures to Control Stagflation 11681,3,Causes of Inflation 11681,4,Factors Affecting Demand 11681,5,1. Increase in Money Supply. 11692,5,2. Increase in Disposable Income. 11692,h,3. Increase in Public Expenditure. 11692,h,4. Increase in Consumer Spending. 11692,h,5. Cheap Monetary Policy. 11704,5,6. Deficit Financing. 11704,h,7. Expansion of the Private Sector. 11704,h,8. Black Money. 11704,h,9. Repayment of Public Debt. 11704,h,10. Increase in Exports. 11715,4,Factors Affecting Supply 11715,5,1. Shortage of Factors of Production. 11715,h,2. Industrial Disputes. 11715,h,3. Natural Calamities. 11727,5,4. Artificial Scarcities. 11727,h,5. Increase in Exports. 11727,h,6. Lop-sided Production. 11727,h,7. Law of Diminishing Returns. 11727,h,8. International Factors. 11727,3,Measures to Control Inflation 11739,4,Monetary Measures 11739,h,Monetary measures aim at reducing money incomes. 11739,5,(a) Credit Control. 11739,h,(b) Demonetisation of Currency. 11750,5,(c) Issue of New Currency. 11750,4,Fiscal Measures 11750,5,(a) Reduction in Unnecessary Expenditure. 11750,h,(b) Increase in Taxes. 11762,5,(c) Increase in Savings. 11762,h,(d) Surplus Budgets. 11774,5,(e) Public Debt. 11774,4,Other Measures 11774,5,(a) To Increase Production. 11785,5,(b) Rational Wage Policy. 11785,h,(c) Price Control. 11785,h,(d) Rationing. 11798,h,Conclusion. From the various monetary, fiscal and other measures discussed above, it becomes clear that to control inflation, the government should adopt all measures simultaneously. Inflation is like a hydra-headed monster which should be fought by using all the weapons at the command of the government. 11798,3,Effects of Inflation* 11798,h,fixed income group and the flexible income group. 11798,4,1. Effects on Redistribution of Income and Wealth 11822,5,(1) Debtors and Creditors. 11822,h,(2) Salaried Persons. Salaried workers such as clerks, teachers, and other white collar persons lose when there is inflation. The reason is that their salaries are slow to adjust when prices are rising. 11822,h,(3) Wage Earners. 11843,5,(4) Fixed Income Group. 11843,h,(5) Equity Holders or Investors. 11846,5,(6) Businessmen. 11846,h,(7) Agriculturists. 11846,h,(8) Government. 11859,h,Conclusion. Thus inflation redistributes income from wage earners and fixed income groups to profit recipients, and from creditors to debtors. 11859,4,2. Effects on Production 11871,h,inflation adversely affects production 11871,5,(1) Misallocation of Resources. 11871,h,(2) Changes in the System of Transactions. 11871,h,(3) Reduction in Production. 11871,h,(4) Fall in Quality. 11871,h,(5) Hoarding and Blackmarketing. 11883,5,(6) Reduction in Saving. 11883,h,(7) Hinders Foreign Capital. 11883,h,(8) Encourages Speculation. 11883,4,3. Other Effects 11883,5,(1) Government. 11894,5,(2) Balance of Payments. 11894,h,(3) Exchange Rate. 11894,h,(4) Collapse of the Monetary System. 11905,5,(5) Social. 11905,h,(6) Political. 11905,3,Inflation as a Tax 11946,3,Costs of Inflation 11946,h,economic or social loss arising from the effects of inflation. 11946,h,Individuals and business enterprises hold cash balances because they yield utility to them. At a higher rate of inflation, they find the purchasing power of the money balances diminishing. 11957,h,The majority of economists also regard the redistributive effects of inflation as the cost of inflation.* 11973,3,Deflation 11973,h,usually associated with falling activity and employment. As 11973,w,Sometimes, deflation is confused with disinflation. 11987,4,Effects of Deflation 11987,h,deflation affects adversely the distribution of income and wealth. When 11999,3,Comparison betwen Inflation and Deflation 11999,h,Keynes, “Inflation is unjust, deflation is inexpedient. 11999,h,all the evils in a capitalist society, unemployment leading to poverty is the worst. 11999,h,Inflation is unjust because it widens the gulf between the rich and the poor. 12011,h,Thus it leads to inequalities of income and wealth. 12011,h,creating shortages and hardships for the common man. 12011,h,socially harmful. People are lured to amass wealth by unscrupulous means. 668 12011: 20150620@ hgx:Deflation, on the other hand, is inexpedient because it reduces national income, output and employment. 12023,h,Keynes pointed out that, “it is not necessary that we weigh one evil against the other. 12023,h,But deflation is a greater evil. Though it redistributes income in favour of the low income groups, yet it fails to benefit them because they are unemployed and have little income during deflation. 12023,3,Control of Deflation 12023,4,Monetary Policy 12045,4,Fiscal Policy 12057,h,But the effectiveness of public expenditure primarily depends upon the public works programme, its importance in the economic system, the volume and nature of public works and their planning and timing. 12057,,b,0150621 12079,2,CHAPTER 38 Business Cycles 12086,h,trade characterised by falling prices and high unemployment percentages.” 12086,3,Types of Business Cycles 12086,5,(1) The Short Kitchin Cycle. 12086,h,(2) The Long Jugler Cycle. 12097,5,(3) The Very Long Kondratieff Cycle. 12097,h,(4) Building Cycles. 12097,h,(5) Kuznets Cycle. 12097,3,Characteristics of Business Cycles 12097,h,Business cycles possess the following characteristics : 12097,5,1. Cyclical fluctuations are wave-like movements. 12097,h,2. Fluctuations are recurrent in nature. 12097,h,3. They are non-periodic or irregular. In other words, the peaks and 12109,5,troughs do not occur at regular intervals. 12109,h,4. They occur in such aggregate variables as output, income, employment and prices. 12109,h,5. These variables move at about the same time in the same direction but at different rates. 12109,h,6. The durable goods industries experience relatively wide fluctuations in output and employment but relatively small fluctuations in prices. 12109,h,7. Business cycles are not seasonal fluctuations such as upswings in retail trade during Diwali or Christmas. 12109,h,8. They are not secular trends such as long-run growth or decline in economic activity. 12109,h,9. Upswings and downswings are cumulative in their effects. 12119,3,Phases of a Business Cycle 12119,h,4,Recovery 12127,4,Prosperity 12151,4,Recession 12163,4,Depression 12175,3,Causes of Business Cycles 12175,4,External Factors 12186,4,Internal Factors 12186,5,1. Bank Credit. 12198,5,Under-Consumption. 12198,h,3. Over-Investment. 12210,5,4. Competition. 12210,h,5. Psychological Causes. 12223,5,6. Innovations. According to Schumpeter, 12223,h,7. Marginal Efficiency of Capital (MEC). According to Keynes, the cycle consists primarily of fluctuations in the rate of investment. 12235,5,Conclusion. 12235,h,To conclude with Samuelson, business cycles are caused both by external and internal factors. The economic system responds to fluctuations in external factors according to its internal factors, and vice versa. 12235,3,Effects of Business Cycles 12246,h,Thus the rich become richer and the poor poorer. 12258,3,Theories of Business Cycles 12258,4,1. Hawtrey’s Monetary Theory 12294,4,Its Criticisms 12294,5,(1) Credit not the Cause of Cycle. 12294,h,(2) Money Supply cannot Continue a Boom or Delay a Depression. 12305,5,(3) Traders do not Depend Only on Bank Credit. 12305,h,(4) Traders do not React to changes in Interest Rates. 12305,h,(5) Factors other than Interest Rate More Important. 12318,5,(6) Inventory Investments do not Produce True Cycles. 12318,h,(7) Does not Explain Periodicity of Cycle. 12318,h,(8) Ignores Non-Monetary Factors. 12318,4,2. Hayek’s Monetary Over-Investment Theory 12354,4,Its Criticisms 12354,5,(1) Narrow Assumption of Full Employment. 12354,h,(2) Unrealistic Assumption of Equilibrium. 12354,h,(3) Interest Rate not the only Determinant. 12364,5,(4) Undue Importance to Forced Savings. 12364,h,(5) Investment does not fall with Increase in Consumer Goods. 12364,h,6. Incomplete Theory. 12364,4,3. Schumpeter's Innovations Theory 12387,h,Schumpeter assigns the role of an innovator not to the capitalist but to an entrepreneur. He does not provide funds but directs their use. 12399,h,Thus Schumpeter's first approximation consists of a two-phase cycle. The economy starts at the equilibrium state, rises to a peak and then starts downward into a recession and continues till the new equilibrium is reached. 12414,4,Its Criticisms 12426,5,(1) Innovator not Necessary for Innovations. 12426,h,(2) Innovations not the Only Cause of Cycles. 12426,h,(3) Bank Credit not the Only Source of Funds. 12426,h,(4) Innovation financed through Voluntary Savings does not produce a Cycle. 12437,5,(5) Full Employment Assumption Unrealistic. 12437,h,prices. Since full employment is an exception rather than the rule. Thus Schumpeter's theory is not a correct explanation of trade cycles. 12437,4,4. The Psychological Theory 12437,h,According to Pigou, expectations originate from some real factors such as good harvests, wars, natural calamities, industrial disputes, innovations, etc. But he attributes the causes of business cycle into two categories : (a) inpulses and (b) conditions. Impulses refer to those causes which set a process in motion. 12474,4,5. The Cobweb Theory 12484,4,Its Assumptions 12496,5,(1) The current year’s (t) supply depends upon the last (previous) year's (t– 1) decisions regarding output level. Hence current output is influenced by last year's price, i.e. P (t– 1). 12496,4,The Theory 12508,5,1. Convergent Cobweb. 12525,h,(2) Divergent Cobweb. 12548,5,(3) Continuous Cobweb. 12548,h,The analysis of the cobweb theory is based upon very restrictive assumptions which make its applicability doubtful. 12557,5,1. Not Realistic. 12557,h,2. Output not Determined by Price. 12557,h,3. Divergent Cobweb Impossible. 12557,h,4. Continuous Cobweb Impractical. 12568,5,5. Not a Theory. 12584,4,6. Keynes's Theory 12584,h,The Keynesian theory of the trade cycle is an integral part of his theory of income, output and employment. 12584,h,mainly due to "a cyclical change in the marginal efficiency of capital, though complicated and often aggravated by associated changes in the other significant short-period variables of the economic system." 12584,h,"the cycle consists primarily of fluctuations in the rate of investment. And 12608,h,must elapse before recovery begins, depends partly upon the magnitude of the normal rate of growth of the economy and partly upon the length of life of capital goods. 12608,h,Keynes's theory of the trade cycle is superior to the earlier theories because "it is more than a theory of the business cycle in the sense that it offers a general explanation of the level of employment, quite independently of the cyclical nature of changes in employment." 12608,5,(1) Overemphasis on the Role of Expectations. 12621,5,(2) Psychological Theory. 12621,h,(3) Explanation of Crisis Wrong. 12621,h,(4) Incomplete Theory. 12621,h,(5) Not Based on Empirical Data. 12621,h,(6) One-Sided Theory. 12621,4,7. Samuelson's Model of Business Cycle 12621,h,Yt = Gt + Ct + It ...( 1)
      where Yt is national income Y at time t which is the sum of government expenditure Gt , consumption expenditure Ct and induced investment It. 12621,h,Ct = aYt– 1 ...( 2)**
      It = ß( Ct– Ct– 1) 12666,4,Table 1. Samuelson's Interaction Model 12700,5,(2) This model assumes that the marginal propensity to consume (a) and the accelerator (ß) are constants, but in reality they change with the level of income so that this is applicable only to the study of small fluctuations. 12700,4,8. Hicks’s Theory of Business Cycle 12752,h,Hicks writes in this connection: “I shall follow Keynes in assuming that there is some point at which output becomes inelastic in response to an increase in effective demand.” 12763,h,The Hicksian theory of the business cycle has been severely criticised 12779,h,Duesenberry, Smithies and others 12779,5,1. Value of Multiplier not Constant. 12779,h,2. Value of Accelerator not Constant. 12779,h,3. Autonomous Investment not Continuous. 12792,5,4. Growth not Dependent only on changes in Autonomous Investment. 12792,h,5. Distinction Between Autonomous and Induced Investment not Feasible. 12792,h,6. Ceiling Fails to Explain adequately the onset of Depression. Hicks has been criticised for his explanation of the ceiling or the upper 12805,5,7. Explanation of Floor and Lower Turning Point not Convincing. 12805,h,8. Full Employment level not Independent of Output Path. 12817,5,9. Explosive Cycle not Realistic. 12817,h,10. Mechanical Explanation of Trade Cycle. 12817,h,11. Contraction Phase not Longer than Expansion Phase. 12817,h,But the actual behaviour of the postwar cycles has shown that the expansionary phase of the business cycle is much longer than the contractionary phase. 12817,5,Conclusion. 12817,h,Despite these apparent weaknesses of the Hicksian model, it is superior to all the earlier theories in satisfactorily explaining the turning points of the business cycle. 12829,5,9. Goodwin's Trade Cycle Model 12844,4,Cyclical Path 12922,h,the weaknesses of Goodwin's model. 12922,4,Differences between Goodwin and Hicks Models 12935,4,10. Friedman's Theory of Business Cycles* 12935,h,(i) changes in economic activity have always been accompanied by changes in the money stock; (ii) there have not been major changes in the money stock that have not been accompanied by changes in economic activity; and (iii) changes in the stock of money have been attributed to a specific variety of exogenous factors rather than to changes in economic activity. 12997,5,(1) Monetary Changes not the Only Cause of Changes in Economic Activity. 13008,5,(2) Monetary Changes not the Main Cause of Business Cycles. 13008,h,(3) Time Lag of Peaks and Troughs not Long and Variable. 13008,h,Despite these criticisms, it cannot be denied that one of the important causes of business cycles is "a dance of the dollar." 13008,4,11. Kaldor's Model of the Trade Cycle 13071,5,Contraction Phase. 13099,3,Measures to Control Business Cycles or Stabilisation Policies 13099,4,1. Monetary Policy 13099,h,Monetary policy as a method to control business fluctuations is operated by the central bank of a country. 13099,h,boom, it raises its bank rate, sells securities in the open market, raises the reserve ratio, and adopts a number of selective credit control measures such as raising margin requirements and regulating consumer credit. Thus the central bank adopts a dear money policy. 13110,h,To control a recession or depression, the central bank follows an easy or cheap monetary policy by 13110,4,Limitations of Monetary Policy 13110,h,2. Fiscal Policy 13121,5,Policy during Boom. 13121,h,government tries to reduce unnecessary expenditure 13121,h,policy of having a surplus budget when the government revenues exceed expenditures. 13121,h,borrow more from the public 13134,h,Policy during Depression. During a depression, the government increases public expenditure, reduces taxes and adopts a budget deficit policy. 13134,h,public works as roads, canals, dams, parks, schools, hospitals and other construction works. 13134,4,3. Direct Controls 13145,h,Therefore, all methods should be used simultaneously. 13168,1,Part-VI Growth Models 13169,2,CHAPTER 39 The Harrod-Domar Models 13169,3,Requirements of Steady Growth 13175,h,investment. Firstly, it creates income, and secondly, it augments the productive capacity of the economy by increasing its capital stock. 13197,3,The Domar Model 13197,5,Increase in Productive Capacity. 13209,5,Required Increase in Aggregate Demand. 13209,h,fundamental equation of the model: 13224,h,net autonomous investment (? I/ I) must be equal to as (the MPS times the productivity of capital). 13234,3,The Harrod Model 13247,5,The Warranted Rate of Growth. 13247,h,The warranted rate of growth is, according to Harrod, the rate “at which producers will be content with what they are doing.” 13289,h,is less than saving and that the aggregate demand falls short of aggregate supply. The result is fall in output, employment, and income. There would thus be chronic depression. 13301,5,The Natural Rate of Growth. 13325,4,A Comparative Study of the Two Models 13344,5,Points of Difference. 13357,3,Limitations of these Models 13357,5,(l) The propensity to save ( ? or s) and the capital-output ratio (s) are assumed to be constant. 13368,5,(2) The assumption that labour and capital are used in fixed proportions is untenable. 13368,h,(3) The two models also fail to consider changes in the general price level. 13368,h,(4) The assumption that there are no changes in interest rates is irrelevant to the analysis. 13368,h,(5) The Harrod-Domar models ignore the effect of government programmes on economic growth. 13368,h,(6) It also neglects the entrepreneurial behaviour which actually determines the warranted growth rate in the economy. 13380,h,Despite these limitations, “Harrod-Domar growth models are purely laissez-faire ones based on the assumption of fiscal neutrality and designed to indicate conditions of progressive equilibrium for an advanced economy.” 13390,2,CHAPTER 40 The Solow Model of Growth 13432,5,Possible Growth Patterns. 13505,4,A Critical Appraisal 13515,4,Weaknesses 13545,2,CHAPTER 41 The Solow-Swan Models of Economic Growth 13545,3,The Solow-Swan Model 13602,4,Growth with Saving 13616,3,Implications of the Model 13638,2,CHAPTER 42 The Endogenous Growth Theory 13638,h,The Solow-Swan neoclassical growth model explains the long-run growth rate of output based on two exogenous variables: the rate of population growth and the rate of technological progress 13645,3,The Endogenous Growth Models 13657,4,1. Arrow's Learning by Doing and Other Models 13657,5,The Arrow Model. 13672,5,The Levhari-Sheshinski Model. 13686,5,The King-Robson Model. King and Robson emphasise learning by watching in their technical progress function. 13686,h,The Romer Model. 13702,h,Romer takes investment in research technology as endogenous factor in terms of the acquisition of new knowledge by rational profit maximisation firms. 13702,4,2. The Lucas Model 13733,h,,3. Romer's Model of Technological Change 13733,h,In the Romer model, new knowledge enters into the production process in three ways. First, a new design is used in the intermediate goods sector for the production of a new intermediate input. Second, in the final sector, labour, human capital and available producer durables produce the final product. Third, and a new design increases the total stock of knowledge which increases the productivity of human capital employed in the research sector. 13756,4,Romer model can be explained in terms of the following techknological production function, ? A = F (KA, HA, A) 13769,4,Criticisms of Endogenous Growth Theory 13781,5,various models of new growth theory, the difference between physical capital and human capital is not clear. 13781,3,Policy Implications of Endogenous Growth Theory 13792,5,4. This further implies that countries having greater stocks of human capital and investing more on research and development will enjoy a faster rate of economic growth. 13805,2,CHAPTER 43 Steady State Growth 13961,2,CHAPTER 44 The Golden Rule of Accumulation 13967,3,Golden Age and Golden Rule of Accumulation 14060,1,Part-VII Macroeconomic Policies 14062,2,CHAPTER 45 Macroeconomic Policies 14062,h,Macroeconomic policy is achieved through certain instruments and objectives. Its two main instruments are monetary and fiscal policy and its four major objectives are full employment, price stability, economic growth, and balance of payments equilibrium. 14070,3,Policy Targets and Instruments 14070,h,For instance, the government may have the following policy objectives : (1) to achieve full employment at the rate of 3 per cent unemployment; (2) to achieve price stability at an annual inflation rate of 5 per cent per annum; and (3) to attain the growth rate of 5 per cent per annum for the economy. Thus the policy targets of the government are 3 per cent unemployment rate, 5 per cent inflation rate and 5 per cent growth rate per year. On the other hand, policy instruments are those exogenous variables that can be directly influenced by the government. 14083,3,Objectives of Macroeconomic Policy 14083,4,Full Employment 14083,h,Full employment has been ranked among the foremost objectives of economic policy. 14083,h,According to Pigou, the tendency of the economic system was to automatically provide full employment in the labour market. 14093,h,However, this classical view on full employment is consistent with some amount of frictional, voluntary, seasonal or structural unemployment. 14093,h,Thus the problem of full employment is one of maintaining adequate effective demand. 14107,h,Thus the Keynesian concept of full employment involves three conditions: (i) reduction in the real wage rate; (ii) increase in effective demand; and (iii) inelastic supply of outut at the level of full employment. 14107,h,frictional unemployment of 3% in a full employment situation for England. 14119,4,Price Stability 14130,h,Differential price changes are essential for allocating resources in the market economy. 14156,h,Generally, economists believe in the possiblity of continual growth. 14156,h,The economy may not grow further if there is no improvement in the quality of labour in keeping with the new technologies. 14168,4,Balance of Payments 14168,h,Another objective of macroeconomic policy since the 1950s has been to maintain equilibrium in the balance of payments. 14178,h,What is the balance of payment target of a country ? 14179,h,A deficit in the balance of payments of a country can be wiped out with restrictive monetary and fiscal policies, by reducing imports and encouraging exports, and by devaluation of the currency. 14179,3,Conflicts or Trade-Off in Policy Objectives 14203,h,Thus unskilled workers are the worst sufferers because they are thrown out of jobs with automation. 14214,4,Economic Growth and Price Stability 14214,h,Full Employment and Price Stability 14222,h,Economists do not find any conflict between unemployment and price stability. 14236,4,Full Employment and Balance of Payments 14236,h,Price Stability and Balance of Payments 14247,3,Problem of Coordination of Macroeconomic Policy Objectives* 14258,4,The Swan Model 14270,h,Obviously, points to the right and above the IB curve relate to inflation or over full employment, and points to the left and below the curve refer to recession or unemployment. 14281,h,points above the EB curve refer to a surplus and points below the curve relate to a deficit in the balance of payments. 14311,h,Tinbergen Principle which leads to the assignment problem. The solution to this problem has been suggested by Mundell which we discuss below in detail. 14311,3,The Assignment Problem : The Mundellian Model 14311,4,The Assignment Problem 14311,h,If there are more objectives than policy instruments it means that there are not enough tools to achieve the policy objectives. The system is undetermined. 14311,h,Thus the number of policy tools must equal the number of targets for economic policy to be successful. This has come to be known as the Tinbergen Principle or the fixed targets approach. 14322,4,The Mundellian Model 14387,4,Criticisms of Mundell’s Model 14387,5,1. Unrealistic Assumptions. 14387,h,2. Ignores Stagflation. 14387,h,3. Neglects Other Factors. 14387,h,4. Practical Constraints. 14398,5,5. Cannot Correct Current Account Deficit. 14398,h,6. Not a True Adjustment Mechanism. 14398,h,7. Debt-Servicing Requirements not Considered. 14398,h,8. Retards Capital Formation. 14410,5,9. Conflicting Policies. 14410,h,10. Long Time Lags. 14410,3,Rules vs Discretion in Economic Policy 14422,h,According to Keynesians, the economy is subject to many exogenous shocks from factors like changes in expectations, political events, international events such as oil crisis, war, etc. 14422,h,Therefore, Keynesians argue that government should follow activist fiscal and monetary policies to stabilise the economy. 14422,h,To Keynesians, stabilisation policy means “leaning against the prevailing economic wind.” 14445,4,Expectations, the Lucas Critique and New Classical Stabilisation Policy 14471,3,Lags in Effects of Economic Policy 14482,h,Friedman distinguishes among three basic lags: the recognition lag, the administrative lag, and the operation lag. These lags are explained as under: 14482,5,1. The Recognition Lag. 14482,h,Empirical evidence in the U.S. suggests that in the past the Federal Reserve Bank recognised the need for monetary action only three months after the trough in a business cycle and about six months after a boom had started. Thus the recognition lag has been longer at the peaks than at the troughs. 14482,5,2. The Administrative Lag. 14495,5,3. Operation Lag. 14503,h,Countercyclical policy means “leaning against the prevailing economic winds”. It implies that the authorities follow an easy policy in a recession and a tight policy in a boom. 14516,h,According to Friedman, “We seldom in fact know which way the economic wind is blowing until several months after the event.” 14528,h,Friedman, therefore, calls for an end to discretion in policy. In place of the judgement of monetary and fiscal authorities, he proposes that it should follow a fixed long-run rule, that is to increase the money supply and fiscal deficit at an annual fixed percentage rate regardless of current economic conditions. 14538,h,The Keynesians also do not concur with Friedman’s policy prescription to avoid the lag problems. They favour the use of monetary policy to control a boom, and supplementing monetary policy with fiscal policy to control a recession. 14560,,b,0150714 14564,2,CHAPTER 46 Monetary Policy 14564,3,Meaning of Monetary Policy 14564,h,Objectives or Goals of Monetary Policy 14570,4,1. Full Employment 14570,h,2. Price Stability 14570,h,3. Economic Growth 14570,h,4. Balance of Payments 14579,3,Instruments of Monetary Policy 14579,5,Bank Rate Policy. 14591,5,Open Market Operations. 14591,h,Changes in Reserve Ratios. 14591,h,Selective Credit Controls. 14591,3,Expansionary Monetary Policy 14649,3,Restrictive Monetary Policy 14660,4,Its Scope and Limitations 14660,5,1. Increase in the Velocity of Money. 14660,h,1. Increase in the Velocity of Money. 14678,5,(a) Commercial Bank Portfolio Adjustments. 14691,5,(b) The Role of Non-Bank Financial Intermediaries. 14691,h,(c) Methods to Make Better Use of Available Money Supply. 14703,5,2. Discriminatory. 14703,h,3. Threat to Credit Market. 14703,h,4. Threatens Solvency of NBFIs. 14703,h,5. Alter Expectations of Borrowers and Lenders. A very tight monetary policy may alter the expectations of borrowers 14715,5,6. Time Lags. 14725,2,CHAPTER 47 Classical, Keynesian and Modern Views on Monetary Policy 14725,3,The Classical View 14725,h,Keynes did not agree with the classical view that the supply of money influences the price level directly and that the economy always stays at the full employment level. Moreover, the classical analysis was related to the long-run where market forces worked the economy toward full employment. 14745,3,The Keynesian View 14745,h,contends that a change in the supply of money can permanently change such variables as the rate of interest, the aggregate demand, and the level of employment, output and income. 14745,h,Keynes believed in the existence of unemployment equilibrium. 14745,h,In a situation of unemployment, Keynes advocated cheap money policy. 14767,h,the rate of interest, the lower the demand for money, and vice versa. This negative relationship between the demand for money and the rate of interest provides a link between changes in the supply of money and the level of economic activity. 14767,h,He argued that at a very low interest rate, the demand for money curve becomes perfectly elastic. 14767,h,This is the liquidity trap portion of the demand for money curve which is completely flat. This means that further increases in the supply of money by the monetary authority cannot reduce the rate of interest. This implies that there will be no effect on investment and income, and monetary policy does not influence economic activity. 14767,h,“If we are tempted to assert that money is the drink which stimulates the system of activity, we must remind ourselves that there may be several steps between the cup and the lip.” 14779,h,Recent researches have shown that Keynes was misrepresented by his followers in attributing that he was not a votary of monetary policy. 14779,3,The Modern View 14790,4,Substitution Effects 14790,h,Thus the “neo-Keynesians contend that financial assets are the closest substitutes for money, and that, consequently, increases in the supply of money will have their effect eventually on the level of economic activity by bringing about increases in the output of capital goods industries.” 14802,h,The monetarists led by Friedman are of the view that excess money balances will be used to purchase not only financial assets but also real assets such as houses, land, consumer durables, etc. 14802,4,Wealth Effects 14826,2,CHAPTER 48 The Liquidity Theory of Money 14829,h,Broadly speaking, liquidity means moneyness. Liquidity is characterised by the ease of converting an asset into money at little cost. A liquid asset is one which is easily spendable, marketable (transferable) and has capital certainty. 14851,3,The Radcliffe Committee View : Radcliffe - Sayers Thesis 14851,h,Thus it held the view that “changes in rates of interest only very exceptionally have direct effects on the level of demand.” 14934,2,CHAPTER 49 Fiscal Policy 14937,h,Though the ultimate aim of fiscal policy is the long-run stabilisation of the economy, yet it can be achieved by moderating short-run economic fluctuations. In this context, Otto Eckstein defines fiscal policy as "changes in taxes and expenditures which aim at short-run goals of full employment and price-level stability." 14938,3,Objectives Of Fiscal Policy 14948,3,Instruments of Fiscal Policy 14955,3,Compensatory Fiscal Policy 14963,h,fiscal policy has two approaches: (1) built-in stabilisers; and (2) discretionary fiscal policy. 14963,h,changes in the budget are automatic and hence this technique is also known as one of automatic stabilisation. The various automatic stabilisers are corporate profits tax, income tax, excise taxes, old age, survivors and unemployment insurance and unemployment relief payments. 14971,h,Built-in stabilisers have certain advantages as a fiscal device. They are: 1. The built-in stabilisers serve as a cushion for private purchasing power when it falls and lessen the hardships on the people during deflationary period. 2. They prevent national income and consumption spending from falling at a low level. 3. There are automatic budgetary changes in this device and the delay in taking administrative decisions is avoided. 4. Automatic stabilisers minimise the errors of wrong forecasting and timing of fiscal measures. 5. They integrate short-run and long-run fiscal policies. 14977,3,(2) Discretionary Fiscal policy 15002,h,This policy has the following limitations: 1. The discretionary fiscal policy depends upon proper timing and accurate forecasting. 15026,3,Budgetary Policies— Countercyclical Fiscal Policy 15026,h,Deficit budgeting is an important method of overcoming depression 15032,h,Budget deficit may also be secured by reduction in taxes and without government spending. 15048,3,(2) Surplus Budget— Fiscal Policy during Boom 15058,3,(3) Balanced Budget 15115,3,Crowding out and Fiscal Policy 15145,h,But the total expenditure remains unchanged and fiscal policy has no expansionary effect on national income. 15220,2,CHAPTER 50 Monetarism versus Keynesianism 15220,h,Monetarism refers to the followers of Milton Friedman who hold that " only money matters", and as such monetary policy is a more potent instrument than fiscal policy in economic stabilisation. On the other hand, Keynesianism refers to the followers of Keynes who believe that "money does not matter," 15265,h,Friedman's historical findings show a " stable money demand function" which implies that the demand for money is a stable function of peoples' income. 15289,h,The Keynesian View The Keynesians hold just the opposite views to monetarists about the demand for and supply of money and the aggregate expenditure. Both the demand for and supply of money are highly interest elastic while the aggregate expenditure is not. 15316,h,Thus so long as there is unemployment, output will change in the same proportion as the quantity of money, and there will be no change in prices; and when there is full employment , prices will change in the same proportion as the quantity of money. 15326,h,According to the monetarists, monetary policy has a greater influence on economic activity than fiscal policy, and fiscal policy is important only in making changes in the money supply. On the other hand, the Keynesians emphasise the importance of both fiscal and monetary policy 15432,2,CHAPTER 51 Is And LM Functions: General Euilibrium of Product and Money Markets 15435,3,The Product Market Equilibrium 15515,3,The Money Market Equilibrium 15581,3,General Equilibrium of Product and Money Market 15698,2,CHAPTER 52 Extensions of IS-LM Model 15701,3,Effects of Changes in Monetary and Fiscal Policies by the Government 15717,3,Effects of Changes in Fiscal Policy 15767,3,Monetary-Fiscal Policy Mix 15773,3,IS-LM Model with Labour Market and Flexible Prices 15831,3,IS-LM Model with Flexible Wages and Prices : The Neo-Classical Analysis 15927,3,IS-LM Model in the Keynesian Analysis with Flexible Prices and Fixed Money Wages 16063,2,CHAPTER 53 Effectiveness of Monetary and Fiscal Policy 16066,3,Monetary Policy 16138,3,Fiscal Policy 16242,3,Monetary Policy 16252,4,The Classical or Monetarist Range 16412,,b,0150722 16416,1,Part-VIII Modern Macroeconomics 16418,2,CHAPTER 54 The Rational Expectations Hypothesis 16421,h,From the late 1960s to 1970s, a new phenomenon appeared in the form of both high unemployment and inflation, known as stagflation. This phenomenon of stagflation posed a serious challenge to economists and policy makers because the Keynesian theory was silent about it. Out of this crisis emerged a new macroeconomic theory which is called the Rational Expectations Hypothesis (Ratex). 16423,3,Adaptive Expectations 16445,3,Rational Expectations 16452,h,Muth pointed out that certain expectations are rational in the sense that expectations and events differ only by a random forecast error. 16461,4,Basic Propositions of the Rational Expectations Hypothesis 16483,4,Rational Expectations and the Phillips Curve 16513,h,The Ratex hypothesis assumes that people have all the relevant information of the economic variables. Any discrepancy between the actual rate of inflation and the expected rate is only in the nature of a random crror. 16520,4,Stabilisation Policy and Ratex Hypothesis 16543,h,Thus for expansionary fiscal and monetary policies to have an impact on unemployment in the short-run, the government must be able to fool the people . But it is unlikely to happen all the time. If the government continues to persist with such policies, they become ineffective because people cannot be fooled for long and they anticipate their effects on production and unemployment. 16576,2,CHAPTER 55 Supply-Side Economics 16586,3,Main Features of Supply-side Economics 16593,4,Tax-induced Change in Aggregate Supply 16619,4,Increasing Growth Rate 16626,h,Thus supply-side economists advocate reduction in tax rates in order to increase the incentives to work, save and invest and to get more tax revenue by the government. Increase 16633,3,Policy Prescriptions of Supply-side Economics 16633,4,1. The Laffer Curve : Tax Rate Vs Tax Revenue 16663,4,2. Reduction in Government Spending. 16687,3,Criticisms of Supply-side Economics 16719,,b,0150723 16722,2,CHAPTER 56 The New Classical Macroeconomic 16725,h,The Keynesians advocate demand management policies both fiscal and monetary to stabilise the economy. They favour active interventionist fiscal and monetary policies. They do not regard the two policies as competitive but complementary to each other. 16726,h,In contrast , monetarist hold that the economy is basically stable and when disturbed by some change in basic conditions will quickly revert to its long- run growth path. 16733,3,The New Classical Macroeconomics 16739,h,The new classical macroeconomics is based on the following principles or hypotheses: (1) Markets Continuously Clear (2) Rational Expectations (3) Aggregate Supply Hypothesis 16821,h,This behaviour of workers to substitute current leisure for future leisure and vice versa is known as intertemporal substitution. 16869,3,Policy Implications of New Classical Macroeconomics 16870,4,1. Policy Ineffectiveness Proposition. 16891,4,2. Impotency of Systematic Monetary Policy 16901,4,3. Policy Credibility. 16909,4,4. The Lucas Critique 16923,4,5. Policies to Increase Aggregate Supply. 16930,3,Criticisms of New Classical Macroeconomics 16931,4,1. Rational Expectations Hypothesis Unrealistic. 16938,4,2. Markets do not Continuously Clear. 16945,4,3. Aggregate Supply Hypothesis Unacceptable. 16946,4,4. Policy Implications Unacceptable. 16978,2,CHAPTER 57 The Real Business Cycle Theory 16994,3,Role of Technological Shocks 17015,4,Technological Shock 17060,4,Labour Market 17067,4,Interest Rate 17068,4,Flexibility of Wages and Prices 17073,4,Neutrality of Money 17074,4,Fiscal Policy 17080,4,Criticisms of the Real Business Cycle Theory 17087,5,1. Technological Shocks. 17095,5,2. Other Factors. 17096,5,3. Intertemporal Substitution. 17104,5,4. Voluntary Employment. 17105,5,5. Exchange Mechanism. 17111,5,6. Neutrality of Money 17112,5,7. Wages and Prices. 17119,5,8. Fiscal Policy. 17120,5,9. Negative Technological Shocks. 17121,5,10. Incomplete Theory. 952 17127: 20150723@ hgx:Conclusion. Despite these criticisms, as oberved by Mankiw, "The real business cycle theory has served the important function of stimulating and provoking the scientific debate, but it will ultimately be discarded as an explanation of observed fluctuations." 17132,,b,0150724 17134,2,CHAPTER 58 New Keynesian Economics 17137,3,Differences between New Classical and New Keynesian Macroeconomics 17138,h,1. New classical economists argued that Keynesian economics was theoretically inadequate because it was not based on microeconomic foundations. According to them, macroeconomic models should be based on firm microeconomic foundations. 17150,h,But in new Keynesian models, wages and prices fail to adjust rapidly enough to clear markets within a short time so as to keep the quantity demanded of labour equal to its quantity supplied. But this is an unemployment equilibrium. 17158,3,Main Features of New Keynesian Economics 17164,4,1. Sticky Nominal Wages 17211,5,Staggered Wage Contracts Theory 17230,4,2. Sticky Nominal Prices : Menu Costs Hypothesis 17284,4,3. Sticky Real Wages 17339,w,shirk v. [with obj.] avoid or neglect (a duty or responsibility): I do not shirk any responsibility in this matter. ¦ n. ARCHAIC a person who shirks. shirker n. mid 17th century (in the sense ‘practise fraud or trickery’): from obsolete shirk ‘sponger’, perhaps from German Schurke ‘scoundrel’. - pakolla 17383,4,Policy Implications of New Keynesian Economics 17384,5,1. Monetary and Fiscal Policies. 17408,5,2. Prices and Incomes Policies. 17416,5,3. Government and Corporate Policies. 17431,5,4. Re-establishment of Policy Effectiveness. 17432,5,5. Favour Rough or Course Tuning. 17433,5,6. Existence of Involuntary Unemployment. 17439,3,Criticisms of New Keynesian Economics 17445,h,Blanchard comments that new Keynesian economics has led to the construction of "too many monsters with few interesting results." 17473,h,"Far from being a set of facts looking for a theory, the new Keynesian paradigm suffers from too many unrelated theoretical explanations." Robert Gordon. In the light of this statement, 17479,,b,0150726 17483,1,Part - IX Macroeconomics in Open Economy 17484,2,CHAPTER 59 Balance of Payments: Meaning and Components 17486,3,Structure of Balance of Payments Accounts 17494,h,But in balance of payments accounting, the practice is to show credits on the left side and debits on the right side of the balance sheet. 17560,3,Is Balance of Payments Always in Equilibrium ? 17600,3,Measuring Deficit or Surplus in Balance of Payments 17640,3,Balance of Trade and Balance of Payments 17662,3,Disequilibrium in Balance of Payments 17719,4,Implications of Disequilibrium 17749,3,Measures to Correct Deficit in Balance of Payments 17750,4,1. Adjustment through Exchange Depreciation (Price Effect) 17764,4,2. Devaluation or Expenditure-Switching Policy 17713,4,3. Direct Controls 17779,4,4. Adjustment through Capital Movements 17787,4,5. Adjustment through Income Changes 17788,4,6. Stimulation of Exports and Import Substitutes 17793,4,7. Expenditure-Reducing Policies 17811,2,CHAPTER 60 Adjustment Mechanisms of Balance of Payments 17821,3,Automatic Price Adjustment Under Gold Standard 17837,3,Automatic Price Adjustment Under Flexible Exchange Rates (Price Effect) 17897,3,The Elasticity Approach 17898,4,Marshall-Lerner Condition 17912,h,Given these assumptions, when a country devalues its currency, the domestic prices of its imports are raised and the foreign prices of its exports are reduced. Thus devaluation helps to improve BOP deficit of a country by increasing its exports and reducing its imports. 17913,h,Marshall-Lerner condition states: when the sum of price elasticities of demand for exports and imports in absolute terms is greater than unity, devaluation will improve the country’s balance of payments, i.e. ex + em > 1 where ex is the demand elasticity of exports and Em is the demand elasticity for imports. 17989,3,The Absorption Approach 18038,4,Effects of Devaluation on BOP 18039,5,1. MP to Absorb . 18047,5,2. Income Effects. 18048,5,3. Terms of Trade Effect 18055,5,4. Direct Absorption. 18064,5,5. Real Cash Balance Effect. 18072,5,6. Money Illusion Effect. 18073,5,7. Income Re-distribution Effect. 18087,5,8. Expenditure-Reducing Policies. 18102,3,The Monetary Approach 18240,,b,0150727 18247,2,CHAPTER 61 Balance of Payments Policies : Internal and External Balance 18260,3,Expenditure Changing Monetary and Fiscal Policies 18352,3,Monetary-Fiscal Mix : Internal and External Balance Policies – Mundell-Fleming Model 18354,3,Keynesian Open Economy Model. 18380,3,1. Fixed Exchange Rates with Perfect Capital Mobility 18425,3,2. Flexible Exchange Rates with Perfect Capital Mobility 18455,4,3. Fixed Exchange Rates with Relative Capital Mobility 18499,4,4. Flexible Exchange Rates with Relative Capital Mobility 18526,3,Monetary and Fiscal Policies for Achieving Internal and External Balance Simultaneously – Swan Model 18577,3,The Assignment Problem : The Mundellian Model of Monetary-Fiscal Policies for Internal and External Balance 18583,h,Jan Tinbergen 6 was the first economist to lay down that the number of policy instruments must be equal to the number of objectives. If there are more objectives than policy instruments it means that there are not enough tools to achieve the policy objectives. 18591,h,Robert Mundell by the Principle of Effective Market Classification. 18681,3,Expenditure Switching Policies 18756,h,commercial controls which operate on the goods side of transactions by preventing people from buying certain goods or forcing them to buy others, or providing financial incentives like tariff subsidies, etc. for certain kinds of sales or purchases. 18764,h,But direct controls involve large social costs. They lead to welfare losses when people are prevented from using foreign exchange and import goods.They also involve large administrative costs. 18785,2,CHAPTER 62 Foreign Exchange Rate 18786,3,Meaning of Foreign Exchange Rate 18803,3,Determination of Equilibrium Exchange Rate 18873,3,Theories of Foreign Exchange Rate 18877,4,1. The Mint Parity Theory : Determination Under Gold Standard 18923,4,2. The Purchasing Power Parity Theory 18924,5,1. Defects in Calculating Price Level. 18975,5,2. Comparison of General Price Level a Difficult Problem. 1055 18976: 20150727@ hgx:according to Keynes, “confined to internationally traded commodities, the purchasing power parity becomes an empty truism.” 18982,5,3. Not Applicable to Capital Account. 18990,5,4. Difficult to Find Base Year. 18992,5,5. Structural Changes in Factors. 18993,5,6. Capital is Mobile. 18996,5,7. Changes in Exchange Rates affect Price Level. 19005,5,8. Barter Terms of Trade Change. 19008,h,59. No Free Trade. 19009,h,Such trade restrictions are tariff, import quotas, customs duties and various exchange control devices which tend to reduce the volume of imports. These, in turn, cause wide deviations between the actual exchange rate and the exchange rate set by the purchasing power parity. 19013,5,10. Only Purchasing Power Parity does not Determine Exchange Rate. 19014,5,11. Neglect of Elasticities of Reciprocal Demand 19015,5,12. It is One Sided. 19021,5,13. No Direct Relation between Exchange Rate and Purchasing Power. 19022,5,14. Static Theory 19024,5,15. Long Run Theory. 19025,5,16. Relevant for Bilateral Trade. 19028,5,17. Not Possible to Compute Equilibrium Exchange Rate. 19031,4,3. The Balance of Payments Theory 19100,3,Causes of Changes in the Exchange Rate 19159,2,CHAPTER 63 Foreign Exchange Rate Policy 19162,3,Fixed Exchange Rates 19163,3,Case for Fixed Exchange Rates 19251,3,Flexible Exchange Rates 19269,3,Case for Flexible Exchange rates 19270,3,Case Against Flexible Exchange Rates 19400,3,Hybrid or Intermediate Exchange Rate Systems 19492,4,Dirty Float System 19494,4,Exchange Rate Band 19495,4,Snake in the Tunnel 19496,5,Multiple Exchange Rates System 19598,3,Exchange Rate Regimes in Practice 19655,,b,0150728 19655,,b,0150728,Jhingan-Macro end ### en #eng Jhingan: Macroeconomics M.L. Jhingan: Macroeconomic Theory - e-mail : vrinda@ ndf.vsnl.net.in This is a tremendous book. Having read it all through I would consider the reading a real feat, if I were a student of exonomics. But being a retired teacher of economics I find reading of this book a privilege, a great privilege, which I would gladly grant to all my colleagues being deeply grateful for it to the author M.L. Jhingan. Thanks to the author's perseverance in carefully designed and throughout observed classification of all material reading and recognition of any subject is smooth and pleasant. Systematic usage of headings up to the fifth or sixth level makes it easy to find anything, familiar or new material. With satisfaction do I find properly emphasizes the really great authorities as well as my personal favourites, such as the thunder-mighty founder of the whole discipline Adam Smith, then the grand old man of the science as a powerful tool John Maynard Keynes, both having their heavy word to say even in the present day situation, although with completely new challenges of the modern information technology. I have in mind the awesome advance of automation and simplification of personal participation, but going on just like in the famous pin producing example of Adam Smith. With similar satisfaction do I note lines dedicated to the effective teacher of myself and all of my generation, Paul A. Samuelson, according to whose Economics textbook even I have structured my own, written soon 50 years ago. Further great names of those days as well as still present are Schumpeter, Hicks, whom the latter I have the honour to have even met at an occasion, ... But from my point of view, there are, in my opinion, also some underemphasized authors and a whole field of discipline, which is econometrics. My personal tutor in the art of building and especially solving a macroeconomic econometric model L.R. Klein is mentioned and referred to in a couple of occasion for his fine work about the Keynesian revolution. Also the Dutch Jan Tinbergen. But in my opinion, the significance of econometric models as guidelines in forecasting and formulation of economic policy could be more emphasizes as the practical implementations of all the rich theories presented in this great volume. But to use one of the author's favourite starts in appreciation of versatility of views: 'Despite these limitations...' or 'Despite these criticisms... I full-heatedly recommend this book to any and all teachers of economics as a treasury and reliable source for spreading the knowledge of economics. All five stars with an emphasizes enthusiasm.