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Trev, interest theories - classical and keynes

Classical theory of interest

We assume that the real interst rate is the same as nominal(no inflation). This says that the lower the interest more money is demanded.

When excess of supply occurs the price falls, so the interest rate falls.


A decline in the desire to save should set up an alarm for regression for Keynes. For classical economists just the intrest will fall and less is investment

SO saving falls consumption increases.





The componenets of the expenditure alters, but total income does not alter, just more is consumed.

A rise in the propensity to save:

savings will rise and consumption will fall. For Keynsians this is bad. For classical writters price and interest rate absorb stuff.

The treasury view

1920s mass Ue. Treasury did not see that public work can be a cure.

The rise in interest line chockes off some private investment. Savings have risen

Classical economists Y=C+I+G



Crowding out. Keynes did not belileve that if the desire to invest rises then it can't crowd out itsself.

Keynesian revolution

Deficiency of aggregate demand.

Y<Y* - people dont want to produce-Keynes

Nowadays the constraint is inflation.


Keynes= +ve relationship between the level of consumption and the level of real national income. This is called consumption function

each increment would not beconsumed completly dC/dY<I





Levels of income above Y1 there is saving

The level of investment is det. by 2 factors

1.         Lterm state of confidence by entrepreneurs (state of lterm expectations, the state of animal spirits)

2.         The rate of interest.

Investment schedule is unstable.

We assume that the rate of interest is given (monetary policy), and business confidence 5s same.

The amount spent on goods must equal to the value of output.

The volume of production will adapt itself to the variations in demand for goods and services (no. over-underproduction) -> Income expenditure method.


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