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MONETARY THEORY

MONETARY THEORY. Nedith Rachelle L. Rocillo BS Travel Management . Monetary Theory . Explains the role of money in the economic system. production. distribution. consumption. Goods and Services. Why do prices increase?. Why does production decline?. Monetary Theory .

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MONETARY THEORY

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  1. MONETARY THEORY Nedith Rachelle L. Rocillo BS Travel Management

  2. Monetary Theory • Explains the role of money in the economic system. production distribution consumption Goods and Services

  3. Why do prices increase? Why does production decline?

  4. Monetary Theory • the theory of the value of money. Three theories: (changes in the value of money) • Transaction theory • 2. Cash-balance • 3. Income theory Value of money Flow or use of money and not its value – which causes changes in economic activities.

  5. 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.

  6. Information to be furnished by Creditor • 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

  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.

  8. Regulatory Agency. But a galloping inflation (about 10 percent increase) becomes disruptive in investment, production andconsumption. • a public authority or government agency responsible for exercising autonomous authority over some area of human activity in a regulatory or supervisory capacity. • Regulatory authorities are commonly set up to enforce standards and safety, or to oversee use of public goods and regulate commerce. when prices are rising at double or triple digit rates of 20, 100 or 200 per cent a year. The Monetary Board of the Central Bank of the Philippines is authorized by law to prescribe rules and regulations as may be necessary to carry out the purposes there are corresponding adjustments in salaries and pensions. The worst is astronomical inflation in which the price level increases by 100 percent, 500 percent or even higher.

  9. Based on Ibon Data bank statistics, • The inflation rate: • 71 out of every 100 families were below the poverty line which was P2,503 a month.

  10. rural areas plant adidas grasses insects

  11. When demand for their products falls, production subsequently slows down. This means there will be an increase in unemployment. It is a basic law in economics that when prices increase, quantity demanded decrease (all other things being constant). P D We have to increase the prices of our goods. Inflation means higher cost of production.

  12. The Use of Money 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.

  13. Less production, • Less Employment, • Less Income, and • Less Consumption • Investment, • Employment, • Production, 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.

  14. The Transaction Theory • 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

  15. 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.

  16. Transactions equation of exchange: PT = MV P is the general price level or average price level paid for goods like rice, shoes, lumber, etc. Mis 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. Tis 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. Supply of money Demand for money

  17. To determine the price level, transpose the equation of exchange PT = MV: PT = MV P = MV Supply of Money T T Demand for Money = Price Level T

  18. 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

  19. What will be P? • If there is a change on either of the following (other factors remaining the same or constant): • M is increased by 200,000 • V is increased by 6 • T is decreased by 2,000,000 • M is decreased by 300,000 • V is decreased by 6 • T is increased by 6,000,000 Prices will rise if there is a corresponding increase in M or V or decrease in T. Prices will fall if there is a corresponding decrease in M or V or increase in T. The answers are as follows: P is 1.80 P is 2.00 P is 1.80 P is 1.05 P is 1.00 P is 1.00

  20. 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.

  21. Cash-Balance Theory

  22. 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.

  23. Cash-Balance Equation of Exchange: M = KTP • Mis the average quantity of money available. • Kis the proportion of the year’s volume of trade over which the people decide to retain their purchasing power in terms of cash-balances. • Tis the volume of trade, number of transactions or total number of goods, services, and property rights that are bought in a given period of time. • P is theaverage of goods, services and property rights. • The cash-balance equation simply states that the purchasing power of the available money in the form of cash balance is equal to the value of the commodities, services and property rights. • Followers of the cash-balance theory conclude that, other things remaining equal, the general price level varies in direct proportion to the supply of money, and in inverse proportion to the demand for money. Demand for money Supply of money

  24. P = M M = KTP KT KT KT M KT P =

  25. 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. If V is 12, then K is 1/12.

  26. 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

  27. 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: • P is 25 • P is 40 • P is 2.00 • P is 1.00

  28. Prices will rise if there is a corresponding decrease in K or T. Prices will fall if there is a corresponding increase in K or T. Summing it up, the cash-balance equations relate the dependencies among the supply of money, the quantity of money, and the demand for money at a given point of time.

  29. 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.

  30. 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.

  31. 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. Income theory

  32. 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.

  33. 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.

  34. 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

  35. End.

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