(a) Interest r plus expected capital gain or r minus expected capital loss. The demand for money (liquidity preference) is the crucial variable in Keynesian theory of money. In Keynes’ theory the quantity of money plays a key role in interest rate determination. The Keynesian Theory of the Interest Rate : As a result output (income) increases from Y 0 to K, in part (b).ģ. This shifts the aggregate desired expenditure schedule upward – from E 0 = C 0 + I 0 + G 0 to E 1 = C 0 + I 1, + G 0. In part (a) a fall in the interest rate from r 0 to r, increases investment by ΔI from I 0 to I 1. 9.2 we show the effects of interest rate changes on aggregate demand. For this reason at a higher interest rate (borrowing cost), fewer projects will be accepted. In his view, an investment project will be carried only if its expected rate of return (or marginal efficiency of capital) exceeds the cost of borrowing to finance the project so that the net return from the project is positive. Keynes pointed out that business investment demand depends on the interest rale.

Making a structure in no limits 2