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John Maynard Keynes(1883 - 1946)Father of MacroeconomicsThe GeneralTheory ofEmployment,Interest and MoneyThe ideas of economists and politicalphilosophers are more powerful thancommonly understood; indeed theworld is ruled by little else.
Theory of LiquidityPreferenceInterest rates adjust tobring money supply andmoney demanded intobalance
Interest RatesNominal = Real + InﬂationIf inﬂation is zero, thennominal = real
Money SupplyDiscount RateBond MarketReserve Ratio
InterestRateQuantity of MoneyMD1Money MarketMD2r1r2MoneySupplyMoneyDemandQuantity ﬁxedby the CentralBankEquilibriumInterestRate
Liquidity Theory1. Money Supply is ﬁxed by central bank withpolicy tools (Debt Instrument Market, DiscountRate, Reserve Requirement)2. Money Demand - Liquidity - Interest rate isthe opportunity cost of holding money.3. Equilibrium pressures
InterestRateQuantity of MoneyMoney Marketr2MoneySupplyMoneyDemandQuantity ﬁxedby the CentralBankr1r3
MoneyDemandInterestRateQuantity of MoneyMoney Marketr2MoneySupplyQuantity ﬁxedby the CentralBankr1r3
MoneyDemandInterestRateQuantity of MoneyMoney Marketr2MoneySupplyr1r3
InterestRate1. Price level increases2. Increases demand for money3. Increases interest rate4. Reduces quantity demand of outputMoney Marketr2MoneySupplyMoneyDemandQuantityﬁxed by theCentral Bankr1PriceLevelP2AggregateDemandOutputY2P1Y1Aggregate Demand
Fiscal PoliciesLevel of governmentspending and taxing
Multiplier EffectAdditional shifts inaggregate demand due toexpansionary governmentspending
Marginal Propensity to ConsumeMPCNew income = spend + saveHow much do you spend?75 percentThen you will be saving 25 percent
Marginal Propensity to ConsumeplusMarginal Propensity to Saveequals oneMPC + MPS = 11- MPS = MPC1- MPC = MPS