The income tax burden for low wage workers decreased by $4 billion to 1 percent of the total owed. Doesn’t sound much like a tax cut for the wealthy. So why does Biden keep saying what he says? In the long run, the level of real GDP is determined by the number of workers, the level of technology, and the capital stock (factories, machinery, etc.). None of these elements are affected by the price level. Long-run aggregate supply curve Figure 13.2 So the long-run aggregate supply curve does not depend on the price level; it is a.

The main thrust of Keynes’s criticism of classical quantity theory of money was directed at its conclusion that (i) velocity of circulation is constant, and (ii) full employment of resources is the natural state of a free market economy. Keynes believed that velocity of circulation was volatile and there often existed underemployment of resources due to recessionary conditions in the economy.

Classical economists believed that people demanded money only for transactions purpose and money balances held for transactions purposes were proportional to nominal income. Keynes challenged this viewpoint and held that people could hold income-earning assets such as bonds instead of holding money balances. To the transactions motive for holding money.

If there is wage cut in one industry but not in others, the relative wage structure would change and workers whose wages are cut would consider it unfair. Therefore, Keynes maintained that workers would resist cut in money wages. Resistance would be less if real wages come down due to inflation because that would affect all workers. An increase in money supply can also have negative effects on the economy. It causes the value of the dollar to decrease, making foreign goods more expensive and domestic goods cheaper. With the complex global economy, this can ripple out and affect other nations. Steel, automobiles, and building materials can all cost more.

Keynes added precautionary motive and speculative motive (that is demand for money as an asset for holding money. Income or interest earned on assets such as bonds is the opportunity cost of holding money. The higher the rate of interest on these assets, the less money will be held by the public.

ADVERTISEMENTS:

It is worth noting that people have adjusted their money holdings until what they demand equals what they actually have. If people have more money than what they demand, they will spend either on consumer goods and services or invest more.

On the other hand, if their demand for money to hold is greater than what they presently have, they will try to acquire more money either by reducing expenditure on goods and services or selling some of their assets such as bonds and shares. Keynes laid stress on financial investment in bonds as a major way to reduce one’s money holdings.

The task of a monetary theory is to explain the influence of changes in money supply on the level of economic activity (i.e., levels of real income, output and employment) and the price level. Keynes’s monetary theory explains the effect of variation in money supply on the level of economic activity through its effect on the rate of interest which determines investment in the economy.

In what follows we first explain the impact of expansion in money supply on the levels of real income and employment. In the second stage of our analysis of Keynes’s monetary theory we show how changes in money supply affect the price level in the economy.

Keynes’s Monetary Theory: Integrating Money Market with Goods Market:

According to Keynes, rate of interest is determined by equilibrium between demand for money and supply of money (i.e., through money market equilibrium).The effect of money supply on rate of interest and the effect of rate of interest on aggregate demand provides a mechanism through which changes in money supply affect the goods market which determines level of economic activity in the economy, that is, level of output and employment.

We know from the study of money market that monetary policy has a profound effect on the rate of interest. Thus, if rate of interest is reduced as a result of an increase in money supply, the rate of investment will rise and the increase in investment will lead to increase in income and employment via the multiplier.

Thus, when in times of recession, money supply in the economy is increased it will cause investment to increase and as result, there will be an increase in aggregate expenditure (i.e., aggregate demand) which will lead to the increase in real national income (aggregate output) and employment will increase, in this way Keynes succeed in integrating money market with goods market.

Does A Cut In Money Supply Affect Real Wage

ADVERTISEMENTS:

Transmission Mechanism:

How, according to Keynes, the change in money supply leads to the increase real income output and employment is shown in the following scheme:The first link in the transmission mechanism is the effect of expansion in money supply on the rate of interest which depends on how far demand for money holdings is sensitive (i.e., elastic) to the changes in rate of interest. The expansion in money supply (M^S) causes the rate of interest to fall.

The second step in the transmission mechanism is the influence of change in rate of interest on the rate of investment, which is determined by the elasticity of investment with respect to rate of interest. The fall in rate of interest leads to the increase in investment in the economy.

The next step in the process is the effect of increase in investment on aggregate demand and therefore on national income (aggregate output) and employment in the economy. The effect of investment on income, output and employment is determined by the size of multiplier.

We explain below at length the above factors and show how the increase in money supply affects the level of economic activity. It may be noted that expansion in money supply which leads to the increase in aggregate demand will affect both the real national income (i.e., GNP) and the price level jointly. However for better understanding of the subject by the students we shall explain the Keynesian monetary theory with regard to the relation between money supply and price level separately as well.

Money Supply and Rate of Interest:

Rate of interest, according to Keynes, is a purely monetary phenomenon. Demand for money to hold depends on the level of income and rate of interest. At a higher current rate of interest, less money is demanded by the people to hold and vice versa.

Therefore, money demand curve (M^d) or what Keynes calls liquidity preference curve slopes downward as shown by M^d curve in Fig. 21.1. Rate of interest is determined by demand for money and supply of money.This is shown in Fig. 21.1 where the quantity of money fixed by the Government is OM^d so that money supply curve is M₁^S. The intersection of demand for money curve M and the supply of money curve M₁^S determines r rate of interest. Thus at rate of interest r₁ demand for money to hold is equal to the available supply of money M₁.

Now, observing that there is unemployment of labour and other resources and recessionary conditions prevail in the economy, the central bank takes steps to raise money supply. The central bank can raise money supply by purchasing Government securities from the market (that is undertaking open market operations) or lowering cash-reserve ratio (CRR) of the banks.

ADVERTISEMENTS:

Suppose ultimately these steps lead to the expansion in money supply to M₂. It will be seen from Fig. 21.1 that with the increase in money supply from M₁ to M₂, rate of interest falls to r₂ at which demand for money holdings equals the increased supply of money M₂.

It may however be noted that the extent to which rate of interest falls as a result of expansion in money supply depends on the elasticity of demand for money holdings with respect to the rate of interest. The higher the elasticity of demand for money with respect to the rate of interest, the smaller the fall in rate of interest as a result of increase in money supply by the central bank of a country.

Rate of Investment:

The next link in the chain of causation is the effect of change in rate of interest on rate of investment in the economy. In the Keynesian system, investment in the economy depends on the rate of interest on the one hand and marginal efficiency of investment (

Does A Cut In Money Supply Affect Real Wage