State whether the statements below are true or false and explain your answer in detail. If...

State whether the statements below are true or false and explain your answer in detail. If you are uncertain, make sure that you explain why.

In the classical model, the rate of interest is determined by the investment and the saving functions. However, in the Keynesian model, the rate of interest is determined by the equality of aggregate output (GDP) with aggregate expenditure (Y=C+I+G).

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Expert Solution

The statement below is uncertain because while the statement "in the classical model, the rate of interest is determined by the investment and the saving functions" is true, the statement,"in the Keynesian model, the rate of interest is determined by the equality of aggregate output (GDP) with aggregate expenditure (Y=C+I+G)" is not true.

In the classical model, the rate of interest is determined by the investment and the saving functions. The equilibrium interest rate is where the amount of savings is equal to the amount of investment in an economy. In the classical model, the supply of money increases when the interest rate increases, for example, when the interest rate increases from 4 percent to 6 percent, people would save more money in the banks than before. The demand for money is determined by the interest rate, i.e. as the interest rate increases the demand for money decreases since higher interest rate increases the cost of borrowing money.

The rate of interest in the Keynesian Theory is determined by the demand and supply of money. The demand for money can be divided into three parts. namely, Transaction motive, Precautionary motive and Speculative motive. The transaction motive is the amount of money needed to spend for day to day transactions, the precautionary motive is the amount of money needed to keep aside for future uncertainties such as accidents, natural calamities, etc, the speculative demand for money is the money needed for speculative purposes in the market regarding expected changes in the rate of interest. The supply of money on the other hand depends on the Central Bank of the nation who print the money. So, according to Keynes, the equilibrium interest rate is where the supply for money is equal to the demand for money.

Rahul Sunny answered 10 months ago

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