Download monetary theory

Nedith Rachelle L. Rocillo
BS Travel Management

Explains the role of money in the economic
system.
the theory of the value of money.
Value of money
Flow or use of money and
not its value – which causes
changes
in
economic
activities.
Finance Charge
 A fee charged for the use of credit or the extension of
existing credit.
 interest,
 fees,
 service charges discounts, and
 such other charges incident to the extension of credit
Creditor
 Any person engaged in the business of extending credit who
requires as an incident to the extension of credit, the
payment of a finance charge.
1.
2.
3.
4.
The cash price or delivered price of the
property or service to be acquired
The amounts, if any, to be credited as down
payment and/or trade-in
The difference between the amounts set
forth under clauses (1) and (2)
The charges, individually itemized, which
are paid or to be paid by such person in
connection with the transaction but which
are not incident to the extension of credit
5.
6.
7.
The total amount to be financed
The finance charge expressed in terms of
pesos and centavos; and
The percentage that the finance charge
bears to the total amount to be financed
expressed as a simple annual rate on the
outstanding
unpaid
balance
of
the
obligation.

a
public
authority
or
But a galloping inflation (about
10
government agency responsible
percent increase) becomes disruptive in
for
exercising
autonomous
investment, production
andconsumption.
when
prices are
authority
some
area of
The
Monetary over
Board of
the Central
Bank
rising at double
or
human
activityisinauthorized
a regulatory
or to
of of
the Philippines
by law
triple digit rates
rules capacity.
and regulations as may
supervisory
20, 100
or 200
per
The worst is astronomical
inflation
inprescribe
cent a year.
which the price level increases
by 100be necessary to carry out the purposes
are corresponding adjustments in
percent, 500 percent or even higher. there
 Regulatory
authorities
are
salaries and pensions.
commonly set up to enforce
standards and safety, or to
oversee use of public goods and
regulate commerce.


The inflation rate:
OCTOBER
PERCENT
1983
9.10
1984
63.82
71 out of every 100 families were below the
poverty line which was P2,503 a month.
is a basic law in economics
When demandIt for
their products falls, production
that when prices increase,
subsequentlyquantity
slowsdemanded
down. This
means there will
decrease
(all other things
being
be an increase
in unemployment.
We have to
increase the
prices of our
goods.
constant).
P D
Inflation means
higher cost of
production.
The income theory claims that the use of money can have great influence
on economic activities even though its value does not change.
Income theorists believe
that their theory is better
than the money-of-value
theories (transactions and
cash-balance
theory)
because it clearly shows
how the flow of income or
money causes economic
changes.




Investment,
Employment,
Production, and
Consumption




Less
Less
Less
Less
production,
Employment,
Income, and
Consumption
Income theorists believe
that the value-of-money
theories were only suitable
during the early years
when the economy was
highly competitive, and
when
prices
were
determined by demand
and supply forces.
States that the value of money (like goods and
services) is determined by demand and supply in a
given market at a given time.
The three determinants of money value are the
following:
average quantity of money available
Average velocity, and
The volume of trade
S
D = P , its value falls
D
S = P , its value rises
It can be stated therefore that other things
remaining equal (determinants of the value of
money), the general price level varies in direct
proportion to the supply of money, and in
inverse proportion to the demand for money.
PT = MV
P is the general price level or average price level paid for
goods like rice, shoes, lumber, etc.
M is the average quantity of money available
throughout the year or other period of time.
V is the velocity of money in the same period or the
number of times the money is spent in one year.
T is the volume of trade, number of transactions or total
number of goods, services, and financial instruments
that are brought in the market in a given period.

To determine the price level, transpose the equation of
exchange PT = MV:
PT = MV
T
T
P = MV
T
Supply of Money
Demand for
Money
Price Level
=
What will be the P?

M = 1,000,000; V = 18; and T = 12,000,000
P = MV/T
=1, 000, 000(18)
12,000,000
= 18, 000,000
12,000,000
= 1.50
Thus, the equation MV = PT will be:
1,000,000(18) = 1.50 (12,000,000)
18,000,000 = 18,000,000
What will be P?

If there is a change on either of the following (other
factors remaining the same or constant):
M
is increased
200,000
Prices
will by
rise
if there is a corresponding
 V is increased by 6
increase in M or V or decrease in T.
 T is decreased by 2,000,000
 M is decreased by 300,000
will by
fall6 if there is a corresponding
 Prices
V is decreased
in M
or V or increase in T.
 decrease
T is increased
by 6,000,000

The answers are as follows:
1. P is 1.80
2. P is 2.00
3. P is 1.80
4. P is 1.05
5. P is 1.00
6. P is 1.00

In a nutshell, the transactions equation explains the
interdependencies existing among the quantity of
transactions and the level of prices over a period of time.
Cash-Balance Theory
Transaction Theory
• stress the value of
money as the main
determinant of economic
activities.
• stress the value of
money as the main
determinant of economic
activities.
•Determine the value of
money
through
the
demand
and
supply
relationships.
•Determine the value of
money
through
the
demand
and
supply
relationships.
•The supply of money • supply of money refers
refers to the cash- to the velocity of money.
balances
or
money
holdings of the people.

Some reasons why people like to hold
cash/retain cash-balance:
To be able to buy goods and services in the
future.
To be able to meet unexpected expenses like
accidents or sickness.
Business Corporations, on the other hand,
maintain cash-balances for financial stability or
future investments.
Cash-Balance Equation of Exchange:
M = KTP
M is the average quantity of money available.
K is the proportion of the year’s volume of trade over which the
 The
cash-balance
equation simply
that that,
the
Followers
of the cash-balance
theorystates
conclude
people decide to retain their purchasing power in terms of cashpurchasing
power
of the available
money
in the form
of
other things
remaining
equal,
the
general
price
balances.
cash
is equal
the value of to
thethe
commodities,
level balance
varies in
directtoproportion
supply of
and
rights.
Tservices
is the volume
of trade,
number
of transactions
totaldemand
number
money,
andproperty
in
inverse
proportion
to or
the
of goods,
services, and property rights that are bought in a given
for
money.
period of time.
P is the average of goods, services and property rights.
P=M
KT
M = KTP
KT KT
M
KT
P
=
V in the transactions equation and the K in the cash-balance
equation, are closely related. Both are determined by exactly the
same forces. The velocity of money depends on the decision of
owners to spend or save it.
Velocity of money becomes greater when people decide to spend
their money as fast as they can. Keeping or hoarding money for
future purchases, decreases the velocity of money.
V and K are reciprocal to each other. IfV is 12, then K is 1/12.
What will be P?
M = 1,000,000 ; K = 1/6 ; and T = 12,000,000
P = M/KT
= 1,000,000
1/6 (12,000,000)
= 1,000,000
2,000,000
= .50
Thus, the equation M = PKT will be:
1,000,000 = (.50)(1/6)(12,000,000)
1,000,000 = 1,000,000
What will be P?
 If there is a change on either of the following (other factors
remaining the same or constant):
K is increased from 1/6 to 1/3
T is increased from 12,000,000 to 15,000,000
K is decreased from 1/6 to 1/24
T is decreased from 12,000,000 to 6, 000,000
 The answers for the above problems are as follows:
1. P is 25
2. P is 40
3. P is 2.00
4. P is 1.00
Summing
Prices
will
it up,
risetheifcash-balance
there is a
corresponding decrease
equations
relate in K or
the
T.
dependencies among the supply
Prices
of
money,
will
the fall
quantity
if there
of money,
is a
corresponding
and
the demand
increase
for money
in K oratT.a
given point of time.
Quantity Theory of Money Re-emphasized
 States that “other things remaining unchanged, a change in
the quantity of money will result in proportional changes in
the price level”.
 The quantity theory of money expresses the view that
changes in M cannot cause changes in V and T. However,
changes in M will result in proportional changes in P.

Transaction Equation (MV = PT)
MODIFIED FORM:
PT = MV + M’V’
M’ refers to the amount of money substitutes (credit instruments),
and V’ refers to the velocity (rapidity) of money substitutes.
What will be P?
P = MV + M’V’
T
= 1,000,000 (18) + 1,000,000 (18)
24,000,000
= 36, 000, 000
24,000,000
= 1.50
Quantity theory is a useful tool in
understanding long-run monetary
and
economic
problems.
Nevertheless, its usefulness in
short-run problems of economic
and monetary stability is not a
remote responsibility.
INCOME THEORY



Maintains that changes in the economy are not
influenced by the changes in the value of money or
price levels.
The theory stresses the production of new goods, and
the speed of spending factor of incomes (wages,
rents, interests and profits) for products.
It explains the workings of the economic system
through the interactions of the various aggregates like
investments, income, consumption and savings.

The value of money according to the theory is determined by
the savings-investment relationship.
If S = I, there is no movement in the price level.
If S > I, there is a downward pressure on prices.
If I > S, there is an upward pressure on prices.

Savings – refer to the supply of money and investments to the
demand for money.
However, the income theorists
contend that the changes in prices do not
depend only on savings-investment
relationships, but also on the availability
of the idle factors of production (land,
labor, and capital), and the degree of
control made by the enterprises in the
various fields of the industry.
Developed the fundamental equation Y = C + I, where
• Y being aggregate income;
• C being the amount spent for goods for consumers;
• I being the amount spent for, and consequently
received in the production of, investment goods (capital)
From such a basic equation, other useful equations may
be clearly inferred and deduced like: Y – C = S, where
• S being the amount of savings left between aggregate
income less that amount spent for consumption;
Y = C + I; Y = C + S; I = Y – C.
Therefore, S = I
JOHN MAYNARD KEYNES