Main propositions of Keynes’ income-expenditure theory of money are given below

Main propositions of Keynes’ income-expenditure theory of money are given below:

1. Money income (Y) is equal to the money value of aggregate real output (PO):

Y = PO

Money income (Y) is defined as the total income received by the factors of production in the form of rent, wages, interests and profits during a period. It represents money value of aggregate real output during that period.

Real income (O) refers to the total volume of goods and services produced by the community during a period. In this way, money income and real income are the two sides of the same coin.

Money value of real income {/. e., real income (O) multiplied by the prices level (P)} is the money income. The nature of the productive process in a capitalist economy is such that, when it increases output and employment, it also generates money income sufficient enough to buy the output at the current prices.

2. Prices (P) are determined by the ratio of money income (Y) and real income (O):

Prices change with the change in the ratio of money income and real income. If money income raises more rapidity than real income, prices will tend to rise. If, on the contrary, real income rises more rapidly than real income, prices will tend to fall.

3. Money income (Y) is spent on consumer goods (C) or saved (S):

Y = C + S

People spend their income on consumer goods and the balance, if any, is saved. Saving is that portion of income which is not consumed (S = Y – C); it is nothing but unconsumed output.

4. Real income (O) depends upon aggregate demand (AD) or total expenditure (E):

O = AD = E

Real income or output depends on the availability of real resources and their employment in the productive processes. In an economy that level of output is produced and that quantity of labour is employed which is the most profitable.

The most profitable output and employment level depends on aggregate demand or total expenditure on goods and services. Aggregate supply (AS) adjusts itself to aggregate demand (AD).

5. Total expenditure (AD = E) comprises of consumption expenditure (C) and investment expenditure (I)

AD = E = C + I

Total spending is made on consumer goods and investment goods. The former is determined by the level of real income and the propensity to consume of the income earner. The latter is determined by the marginal efficiency of capital (i.e., the profitability of capital) and the current rate of interest.

6. Total money income (Y) is equal to total expenditure (C + I):

Y = C + I

Total income and total expenditure are equal because one person’s expenditure is another person’s income. In fact, there is a circular flow between income and expenditure through which both determine and multiply each other.

A’s expenditure becomes B’s income; B’s expenditure becomes C’s income and so on. Thus, expenditure generates income and income generates further expenditure and so on.

7. Money income is the strategic Variable determining output and prices:

Money income determines aggregate expenditure. An increase in the money income increases the purchasing power in the hands of the people who will spend it on buying larger quantities of goods and services than before.

The demand for goods and services will go up. Now, there are three possibilities:

(a) If the production is perfectly elastic, the increase in aggregate demand will raise the level of output and employment without affecting the price level.

(b) If the production is relatively inelastic due to the existence of some bottlenecks i.e., due to the shortage of raw materials, labour, etc., the increase in aggregate demand will partly increase production and partly increase prices.

(c) If the production is perfectly inelastic, i.e. it cannot be increased further due to full employment of resources, the increase in the aggregate demand will proportionately increase prices without affecting production of the economy.

The quantity theory of money established a wrong causal link between the money supply and the aggregate expenditure. According to the quantity theory, it is the quantity of money and its velocity which determines the aggregate expenditure.

According to the income theory, it is the, flow of expenditure which determines the quantity of money and its velocity. An increase in the flow of total expenditure on final goods and services will necessitate an increase either in money or in its velocity or in both.

It is like saying that, if a man grows fat, he will require a larger belt. But, according to the quantity theory, if you first arrange a large belt, you will in consequence of this action necessarily grow fat.

This, however, does not mean that the income theory of money denies an important role to the money supply. An increase in money supply can cause an increase in spending.

But the income theory stresses the point that there is no direct route from quantity of money to the level of expenditure or income.

Whether increased money supply leads to an increase in expenditure depends upon many in between links such as,

(a) The interest elasticity of the investment function,

(b) The sensitiveness of the consumption function to shifts in the rate of interest, and

(c) The interest elasticity of the liquidity preference function. Ultimately the role of money depends upon what part does money play in income determination.