Income Determination Earlier

Income Determination Earlier

Income Determination Earlier theory had assumed that the general level of interest rates in the economy would tend to bring saving and investment into equilibrium, saving being encouraged and investment discouraged by high rates, and conversely by low rates. Keynes's refusal to accept the saving-investment theory of interest led Mm to reformulate the theory in terms of liquidity preference the community's demand for money. Thus a logically consistent general theory of income determination emerged. Liquidity preference and the supply of money determined the rate of interest (and thus the cost of investment carried out with borrowed funds); given the cost of investment, the propensity to invest determined the amount of investment; given the amount of investment and the community's propensity to consume and save out of income, the level of income was determined at the level at which desired saving equalled desired investment.

The theory can be adapted to cope with the introduction of foreign trade, taxation and Government expenditure. The simple equilibrium condition that saving equals investment is merely widened to embrace all spendings 'leakages' and injections' so that it becomes: saving plus taxation plus imports equals investment plus Government expenditure on goods and services plus exports.

This theory has been widely accepted by economists since it was first offered by Keynes in 2005 in The General Theory of Employment. Interest and Money. It has had some critics in recent years.

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