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Unit-13: Keynesian Approach

The Algebra of Keynesian Theory of Money and Prices Notes

Or
Keynes’ fundamental equation

Keynes; is show his idea related to prices and money as the following equation-
Y = E + Q ...(1)
(y: National Income; E: Payment for sources; Q: windfall profit)
The national income (Y) is the addition of payments for resources (E) and windfall profit (Q).
Windfall profits are measure by subtracting the actual sell and sources payments. Only normal profits
are gained in the condition of Y = E.
O = R = C ...(2)
(O: Total production; R: Customer things, C: Capital things )
S = E – PR ...(3)
(S = Savings; PR: consumption things (R) their price (P))
I = P C ...(4)
1
(I = investment expenditure (C) their price (P ) multiplying it)
1
+
PR P C
n = 1 ...(5)
O
(n: Normal price level)
It represents the ratio of total expenditure (PR + P C) and total production (O).
1
Because PR = E – S (S = E – PR is from equation 3 ) and P C = 1.
1
Because the equation (5) can be write"

−+
E S I
n =
O
Or
−
E IS
n = +
O O
It is the basis equation of Keynesian principle related to currency and price. The
E
important part is like that- (i) , the ratio of total production and payment of source and
−
IS O
(ii) mean the ratio of total production and the subtraction of I and S
O
E IS
−
Keynes; consider constant to O and his attention to centralize on O because can describe this
things that how is effect the price level. In this reference the following observation is important-
(i) The reason in the difference of investment (I) and saving (S) is the difference in the natural
rate and market rate of interest. The market rate of interest is the rate which found in the fix
point in currency market. The natural rate of interest is the rate which is analog the similar
of interest and investment on the full employment level.
(ii) If saving on the level of full employment = Investment, market rate of interest = the natural
rate and price level of interest is constant and there is no sign of change.

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