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Keynesian Theory Of Money And Prices

 Keynesian Theory of Money and Prices

Keynes Reformulated Quantity Theory of Money

Keynes presents the association amidst money, productivity and prices. The thesis points out that

  1. So long there is redundancy, productivity will vary in the same ration as the volume of money and

  2. When there is full employment, prices will vary in the same ration as the volume of money.

Postulations

The following postulations form the basis of the thesis.

  1. All factors of production are in completely elastic supply as long as there is any redundancy.
  1. All redundant factors are standardised, completely divisible and exchangeable.
  1. There are invariable returns to scale so that prices do not hike or drop as productivity hikes.
  1. Effectual demand and volume of money vary in the same ration so long as there are any redundant resources.

Description

Based on the above postulations, Keynesian chain of origination amidst variations in the volume of money and in prices in an indirect one through the rate of interest. So when the volume of money is hiked its first impact is on the rate of interest which tends to drop. Given the marginal competence of capital, a drop in the rate of interest will enhance the amount of investment.

The enhanced investment will hike effective demand through the multiplier effect thereby hiking earnings, productivity and employment. As the supply curve of aspects of production is completely elastic is a circumstance of redundancy, remuneration and non-remuneration aspects are accessible at invariable rate of wage.

There being invariable returns to scale, prices do not hike with enhance in productivity as long as there is any redundancy. Under the stipulation, productivity and employment will increase in the same ration as effectual demand and the effectual demand will hike in the same ration as the quantity of money.

Therefore, as long as there is redundancy, productivity will vary in the same ration as the volume of money and there will be no variation in prices and when there is full employment prices will vary in the same ration as the volume of money. Thus, the reformulated amount thesis of money stresses the point that with hike in the volume of money, prices rise only when the level of full employment is reached and not before this.

This reformulated volume theory of money as illustrated in diagram 1 and diagram 2 where OTC is the productivity curve relating to the amount of money and PRC is the price curve connecting to the quantity of money.

                       

Diagram (1) represents that as the volume of money enhances from O to M, the level of productivity also hikes along the OT portion of the OTC curve. Since the volume of money reaches OM level, full employment productivity OQF is being produced. But after point T the productivity curve becomes vertical for the reason that any further enhance in the volume of money cannot raise productivity beyond the full employment level OQF.

                       

Diagram (2) represents the correlation amidst volume of money and prices. As long as there is redundancy, prices remain invariable whatever enhance in the amount of money. Prices start rising only after the full employment level is accomplished. In the diagram, the price level OP stays invariable at the OM volume of money corresponding to the full employment level of productivity OQF. But enhance in the volume of money above OM raises prices in the same ration as the volume of money. This is represented by the RC portion of the price curve PRC.

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