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Economics doubt P3 and P4, post it all in here!

SalmanPakRocks

SalmanPakRocks

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AlphaBeta said:
can u explain paradox of thrift
and paradox of value
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Paradox of thrift is a situation where savings are done privately and not in Banks, as a result of this, leakage occurs in an economy which disrupts the circular flow of Income.
This is what my Sir told me, actually, there are some disagreements between Keynes economist and monetarist economist about paradox of thrift.

Paradox of value is rather simple, Adam Smith stated that water, which is more useful than diamond has lower value in exchange as compared to diamond. The reason for this is because the law of diminishing marginal utility works with full force in case of water, but in case of diamond, the marginal utility increases when gaining extra diamond. This is because water is abundantly available where as diamond is scarce in supply.
 
SalmanPakRocks

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Waleed007 said:
What determines the money demand? (12)
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This is basically about Liquidity preference theory by Keynes.
The theory states that people demand money for 3 reasons:
1) Transactionary motive
2) Precautionary motive
3) Speculative motive
In case of first two motives, the demand for money is perfectly in-elastic. Even when higher interest rate would be offered, one would not deposit or save money in the banks because this money is needed for day to day transactions and as a precaution in a vault. However, in case of speculative motive, the demand for money is elastic. If higher interest rate would be offered, one would prefer to deposit the money instead of use it and therefore when interest rate increases, the demand for money in case of speculative motive falls.
Now you can draw the graphs for these and also a supply curve for supply of money which would be perfectly in-elastic because according to keynes, the money supply is regulated by the government and it's perfectly in-elastic. The intersection point of the demand and supply would determine the interest rate.
 
SalmanPakRocks

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Martee100 said:
Explain, using the concept of the multiplier, the possible link between a fall in interest rates
and an increase in national income.

Can someone help me with this?
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Explain what multiplier effect is and what happens when government autonomous expenditure increases.
1.png
Government increases the money supply from q1 to q2, due to this, the interest rate falls. As we can see in the 1st diagram. According to lonable funds theory, a fall in interest rate would mean that there would be an increase in demand for capital. The investors would be willing to obtain bank loans because the cost of borrowing is low. Now what happens is that out of all Factor of production, the demand for capital increases. Due to this, more and more capital is employed by the firms in the short-run and therefore, the MEC (marginal efficiency of capital) curve is downwards sloping because producers only increase capital as a factor of mix and not labour or land etc. According to law of diminishing returns, after some time, the efficiency obtained from marginal capital falls but the rate of investments increases.
Therefore as the investments increases, more jobs are available to individuals. As a result of which, the national income of the economy increases. As the national income increases, aggregate demand increases. Due to which, economy experiences increase in GDP at the cost of inflation (Demand pull) in the society.

Draw this diagram
 
SalmanPakRocks

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Martee100 said:
But what do we have to write about the multiplier.

Btw thanks alot. Jazakallah.
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Multiplier is the net change in national income due to government's autonomous expenditure, that is the government spending. It can be calculated by the following formula
k = 1/MPS + MPT + MPM
Then you could write about how government expenditure would induce multiplier effect by creating jobs which would result in increase in income level f consumers thus leading to increase in Aggregate demand which would finally lead to increase in GDP or national income.
 
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David Hussey said:
Can you also tell how to answer this question:

How is the interest rate determined in the money market and how it may change. Explain the loanable fund theory in this regard. [13]
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As the question specified loanable funds theory, we now know that we would have to write about Monetarist views.
You could start off by:
According to Monetarist loanable funds theory, the interest rate is determined by the intersection of demand for money curve and the supply of money curve. The demand for money curve shows the attitude of the investors towards obtaining loans. In case if the interest rate is high, the investors would be reluctant to obtain loans because of the fact that the cost of borrowing would be higher but if the interest rate is lower, the demand for loans would increases as because cost of borrowing would fall. In case of supply curve, it shows the attitude of the savers. In case, when the interest rate is high, the savers would be more willing to deposit their cash to obtain higher rate of return, however, in case if the interest rate is low, the supply of money would fall as the savers would be reluctant to save money as the rate of return would be lower.

You could draw the diagram then and explain it.
 
David Hussey

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SalmanPakRocks said:
As the question specified loanable funds theory, we now know that we would have to write about Monetarist views.
You could start off by:
According to Monetarist loanable funds theory, the interest rate is determined by the intersection of demand for money curve and the supply of money curve. The demand for money curve shows the attitude of the investors towards obtaining loans. In case if the interest rate is high, the investors would be reluctant to obtain loans because of the fact that the cost of borrowing would be higher but if the interest rate is lower, the demand for loans would increases as because cost of borrowing would fall. In case of supply curve, it shows the attitude of the savers. In case, when the interest rate is high, the savers would be more willing to deposit their cash to obtain higher rate of return, however, in case if the interest rate is low, the supply of money would fall as the savers would be reluctant to save money as the rate of return would be lower.

You could draw the diagram then and explain it.
Click to expand...
so we just have to write about the loanable funds theory, should we write briefly about the liquidity preference theory as well?
13 marks just for loanable funds, o_O
 
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