3) Explain carefully the Keyne

3) Explain carefully the Keynesian theory of money demand. Thendiscuss the critiques made by Friedman to the Keynesian theory ofmoney demand.

4) Derive carefully the IS curve and discuss the determinants ofits slope and its position.


Keynes emphasised on liquidity preference of money . Accordingto Keynesian theory of money ,people demand money for three reasons:

Transaction motive : Individuals receive income periodically butcannot spend all of it at once , so this leads to demand for moneywhich is known as transaction demand for money ie used for dailyneeds.

Precautionary motive : When money is held for certainemergencies . This type of money is inelastic to interest rate asthe indiviudal prefers to keep such money for uncertain future.

Speculative motive : This demand for money is to invest in thebonds market or fpr other investment purposes. The interest rateinfluences such demand for money.

Friedman’s theory of money demand is different from Keynesian’sbecause of the following reasons:

Friedman believed that money is a part of wealth theory and hasdifferent uses other than the three narrow categories defined byKeynesian Friedman unlike Keynesian treats money as asset and notjust in the three categories defined by keynesian . he believedthat money has a broader use like time deposits.

Also Friedman extended his theory to permanent income but Keynesdoes not have such distinctions.

Keynesian theory included interest bearing bonds only whereas inFriedman’s theory many variables were included like yield on bondor money.


First graph is the keynesian cross that shows the 45 degree lineand the AE curves. As we can see that an increase in any one of thecomponents of AE curve shifts it (here we are assuming thatinterest rate is rising causing a decline in planned investment anda decline in AE curve from AE2 to AE1.

This leads to a decrease in income from Y2 to Y1.

The IS curve hence shows the inverse relation between income andinterest rate.

Slope of IS curve is a positive slope and depends on variousfactors like

Magnitude of multiplier ie marginal propensity to consume. Morethe MPC , more would be the increase in investment and a higherequilibrium level of income and this makes the IS curve flatterbecause now since with the given change in interest rate , thechnage in national income is higher . And in case of smaller sizeof multiplier the IS curve will be more steep.

Elasticity of investment curve. More the elasticity , more wouldbe the change in investment given a rate of interest , this wouldincrease aggregate demand and hence the level of national income.When investment is inelastic or less elastic then the IS curve issteeper and vice versa.

Shift in position of IS curve

Autonomous expenditure or the AE curve works for the position ofIS curve ie when variables like consumption , government spendingor investments increase or taxes , the AE curve shifts ,where AE =C+I+G, shifting the IS curves . A decrease or increase in thesefactors shift the AE curve accordingly.

(You can comment for doubts )Thank you……

riedman never divided the money into fixed categories , ratherhe kept it to be used as per the individual’s needs and preferencesunlike Keynes which focussed more on idle or active money ie on thecategories of speculative , transaction and precautionarymoney.

2) IS curve represents the conmbinations of interest rate andincome when goods market is in equilibrium.

The following is the derivation of IS curve

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