Ch5 : Keynes and modern quantity theory about

role of money in economy:

1-keynes is link between the price level and

money supply and money demand .

The relationship between money supply and the

price is positive, while this relationship between
.money demand and the price is negative
Keynes equation

*P = n / k+r k

N= MS , K = Md , r = requirement reserve , k* = deposits .

this equation explained the relationship between price level

and money demand and requirement reserve is negative. .

but it is positive with money supply (ms). Keynes assert on the

. (k) and ( k*) in its impact on the price level
 canKeynes is show , the (N) and ( r) •
. be governing by central bank

while ( k) and (k*) not control by •

central bank because these variables
are depending on the public behavior
, there fore the stable in prices is
.subject to stable in ( k , k*)
The stable in ( k , k * ) are depends on the
rediscount rate , if increase ( k * ) , the central
bank can be decrease rediscount rate for
encourage the demand for loans .

but keynes is suggests make changes in ( n )

and r % for the purpose influencing on the ( k )
. and (k *)
the equilibrium in the economic system and stable in the -2 •
: price level

: The stable in price level is happen , if •

.I = s and 2. the absence of the emergency profits •
market interest rate = real interest rate .3 •
: Keynes distinguish between types two from interest rate •

.market interest rate is determined by commercial banks – 1 •

real interest rate is the market return on the -2 •
. investment
Keynes show , if money interest rate less than real interest
rate , the demand for loans is upward , this can be illustrated

:With the following diagram

Expansion credit policy

Increase money supply by make the loans

Emergency profits create

more rise in output and employment

level rise prices

opinions Keynes about effect of money on the-3
prices :
 
a- P = f ( Y, out put )
where : Y = AD , out put = AS

P = Y / output , if Y = 8000 , output = 6000 , so p =

8000 / 6000 = 1.5.

b- absence of a causal relationship between money

: supply and total demand
 
in the classical theory , the change in money
supply equal change in price .

but in keyens , this relation is not positive and

proportionality because money supply affect
on the total demand through change in the
. interest rate
. the relationship between (MS ) , ( MD , r% )-4

when Ms = 0 , rise Md lead to increase interest rate , this -1

means in this the case increased money demand by individuals ,
the interest rate must be raised to persuade individuals to deposits
. their funds in banks or purchase of bonds

but if it was Md = constant , rise money supply lead to decrease -2

. in interest rate
MS
r 2%
r 1% Md 2
Md 1

MS3 MS 1 MS 2

r 3%
r 1%
r 2%
: r % , marginal efficient of capital and investment -5

: Investment is depending on the factors two

. a-money interest rate . b - marginal efficient of capital ( real interest rate )

interest rate is affect on the investment and turn the investment affect on the
. marginal efficient of capital
if marginal efficient of capital is constant , the investment rise with
:. decline interest rate
%r
MEC

investment
investment and total income and effective demand : -6
Keynes indicated that the increase in the investment leads
more rise in total income and employment through
make multiplier of investment.

Multiplier (m) = 1/ 1- mpc.

Change Y = m* change (i)

7- Money supply and the prices level : the Keynesians shows,

that changes in money supply leads changes in the price but
indirectly through affect on interest rate on the investment ,
employment , income and output and the aggregate effective
. demand
according to Keynes , money supply determines
aggregate effective demand through :

1- Marginal efficient of capital.

2- Interest rate.

3-the consumption function.

C= a +bY
In all of these cases ,change in money supply may be
change in (AD) .

:8- assumptions of Keynes model

a-all the resources the employees are
homogeneous and able
substitution .
B-return factors of production are constant.

c- factors of production are receive the same of

.wages
Reasons increase the costs and -9
: prices

a-increase the bargaining of workers

lead to rise in wages without
.increase in their productivity
b- operation law of diminishing
. return in short – run
C-Existence bottlenecks in production due to
perfectly inelastic in supply of resources
d-non homogeneity of resources .
but price according to Keynes not change at
proportional with MS and with change in
. effective demand
keynes distinguish between that case two-9
: with related affect (AD ) on the ( P)

a-full – employment in factor of production ,

any increase in the effective demand lead to
rise in ( p ) and not rise in production or
. . employment
b- un full – employment in factor of production,
any increase in the effective demand lead to
rise in production or employment and not rise
,.in ( p )
The modern quantity theory :

This theory are developed by Milton Friedman , where

he explained the change in (p) is depending on :

1- ( MS) 2-the fluctuations in agriculture production ,

3-distrust in domestic currency , 4- monopoly 5- rise
prices of goods , 6- raise profits by corporations
.. owners
: Also he show existence other factors that affect on the (p) are

P = f ( output , k or Md ). Where : output = production , k = money

: demand

. a-if Ms is constant ,rise in output lead to decline in price

b-the liquidity preference (k)refers to the money demand by

individuals for the purpose of holding it .
Friedman is show money demand is stable
in long run and it is depends on factors
: three

the real income level ( wealth) ,if it is-1

increases , the ( k ) tend to rise , but
Friedman show the (k) increase more than
.the rise in the real income in usa
cost held of money : cost held of money is depend-2
on the interest rate on other assets , such as bonds ,
stocks , if interest rate increase on bonds , the (k) was
become low , because , the opportunity cost to held of
money becomes high .

3-inflation : rise in price level its causes decrease in

.value of money and down ward in money demand
The major results to the theory of quantity :

1- stable in price is required to achieve tradeoff

between money supply and production and
population growth rate.

2-The hyper in MS lead to inflation , but Ms at low

rates lead to depression in economy. it must be
achieve growth in money supply ranges between 3% -
. 5% for avoid the inflation
impact the monetary policy on the inflation-3
is involve lag time or the monetary policy come
their results after period time
Keynesians vs monetarists approach :Following the
differences between the Keynesians vs monetarists
about the relationship between money supply and the
: economic activity

Keynesians believes interest rates are linked -1

between money supply and aggregate demand , while
monetarists are asserts there are number of rates of
return ( including interest rates ) which linkage the
.money supply with ( AD )

the change in money supply affects on the rates of

return assets , which turn affect on the ( AD ) ,when
. AD is changing , its affect on the GDP
Keynesians are believes that Ms has only -2
, indirect effect on the( AD)
but monetarists assert that it has both direct and
. indirect effect on ( AD )

Keynesians views in long run ,change in ( MS) -3

has affect both price and output, when economy
is operation below full employment , but change
in ( ms) will affect only on the (p) when the
. economy has reached to full employment

Monetarists are considering increase money

supply as necessary and sufficient condition for
.rising prices level
Keynesians says the relationship between -4
change in (MS) and national income is unstable, but
. Monetarists , claim that this relation is stable

5- Keynesians believes that relationship between

change in (MS) and national income quite long run ,
Monetarists says that its quite in short run .