06-17-2015, 08:46 PM

Supply of money, as assumed by Prof. Keynes, includes both types of money: currency notes and coins as well as bank credit. Since the supply of money depends upon the monetary policy of government and Central Bank, it can be assumed to remain fixed, at least over a

short period. According to this theory, rate of interest is determined at the point at which the demand and supply of money are equal.

D) Modern Theory of Interest (Hicks & Hensen Theory):

Hicks and Hensen theory has bought the synthesis between Keynes and Classical theory of rate of interest. IS curve is derived from

Classical theory, whereas LM curve is derived from Keynes liquidity preference theory of interest. Rate of interest is determined at the

point at which IS curve and LM curve intersect each other.

short period. According to this theory, rate of interest is determined at the point at which the demand and supply of money are equal.

D) Modern Theory of Interest (Hicks & Hensen Theory):

Hicks and Hensen theory has bought the synthesis between Keynes and Classical theory of rate of interest. IS curve is derived from

Classical theory, whereas LM curve is derived from Keynes liquidity preference theory of interest. Rate of interest is determined at the

point at which IS curve and LM curve intersect each other.

- IS curve = Investment Saving Schedule
- LM curve = Liquidity preference and money supply equilibrium.

- IS curve is locus of different combination of rate of interest and income which shows equilibrium in goods market and also shows

- LM curve shows the different combination of rate of interest and income, which shows equilibrium in money market.
- Equilibrium of Liquidity Preferences (L) and supply of money (M) of Keynesian theory produces LM curve, which implies money market equilibrium.

- Equilibrium of Investment (I) and savings (S) of classical theory produces IS curve which implies goods market equilibri6m.
- IS curve slopes downward to the right— inverse relationship between the level of income and rate of interest.

- LM CURVE MOVES UPWARD TO THE RIGHT ( DIRECT RELATIONSHIP BETWEEN RATE OF INTEREST & LEVEL OF INCOME ).