NEO CLASSICAL THEORY OF INTEREST /LOANABLE FUND THEORY

• LOANABLE FUND THEORY/
  NEO CLASSICAL THEORY
  INTEREST PART 2
  MICRO ECONOMICS/BUSINESS ECONOMICS 2
• MEANING

1. GIVEN BY SWISS ECONOMISTS WICKSELL,OHLIN,MYDRAL AND ROBERTSON.
2. PROF ROBERTSON,” ACCORDING TO LOANABLE FUNDS THEORY,INTEREST IS THE PRICE WHICH EQUATES THE DEMAND  FOR AND SUPPLY OF LOANABLE FUNDS.
3. THE RATE OF INTEREST IS DETERMINED BY THE DEMAND FOR AND SUPPLY OF LOANABLE FUND
4. TAKES INTO CONSIDERATION MONETARY FACTORS LIKE HOARDING OF MONEY AND BANK CREDIT ALONG WITH REAL FACTORS LIKE SAVING AND INVESTMENT IN THE DETERMINATION OF INTEREST.

• SUPPLY OF LOANABLE FUNDS

1. SAVING:- MAIN SOURCE OF LOANABLE FUND THEORY. EFFECTED BY INDIVIDUAL SECTOR,BUSINESS SECTOR AND GOVERNMENT SECTOR. INFLUENCED BY BOTH THE INCOME AND RATE OF INTEREST.  SUPPLY CURVE OF THE SAVING SLOPES UPWARD.
2. BANK CREDIT:- INTEREST ELASTIC. AT HIGH RATE OF INTEREST BANK WILL GIVE MORE CREDIT AND VICE VERSA
3. DISHOARDING : DIS HOARDING OF PAST SAVING. MONEY HOARDED IS GIVEN AS LOAN
4. DISINVESTMENT :-NON REPLACEMENT OF DEPRECIATE ASSETS. THE AMOUNT WHICH IS KEPT FOR REPLACEMENT OF ASSETS GIVEN AS LOAN

• SUPPLY OF LOANBLE FUNDS:- S+B+DH+DI
• DEMAND FOR LOANABLE FUNDS

1. INVESTMENT DEMAND:-MAIN SOURCE OF DEMAND FOR LOANABLE FUNDS IS DEMAND FOR MONEY FOR INVESTMENT ON THE PART OF THE FIRMS. LOWER THE RATE OF INTEREST MORE WILL BE THE DEMAND FOR INVESTMENT AND VICE VERSA
2. CONSUMPTION:-WHEN CONSUMPTION EXPENDITURE EXCEED INCOME THEN PEOPLE BORROW MONEY
3. HOARDING :-WHO WANTS TO HOARD IT. AT LOW RATE OF INTEREST DEMAND WILL BE MORE AS COMPARED TO HIGH RATE OF INTEREST
4. DEMAND FOR LOANABLE FUND:- I+C+H

•  DETERMINATION OF INTEREST

1. DEMAND FOR LOANABLE FUND = SUPPLY OF LOANABLE FUNDS
2. I+C+H=S+B+DH+DI OR
3. (I-DI)+(H-DH) =(S-C)+B
4. NET INVESTMENT +NET HOARDING =NET SAVING+BANK CREDIT

• THE ABOVE EQUATION INDICATES THAT EQUILIBRIUM RATE OF INTEREST IS DETERMINED AT THE POINT WHERE NET INVESTMENT AND NET HOARDING ARE EQUAL TO NET SAVING AND BANK CREDIT
• DETERMINATION OF INTEREST
• D
  
• EXPLANATION
• TOTAL DEMAND AND SUPPLY INTERSECT AT E POINT AND OR IS THE EQUILIBRIUM RATE OF INTEREST.
• PROF WICKSELL HAS REFERRED TO TWO TYPES OF INTEREST:-

1. MARKET RATE OF INTEREST OR EQUILIBRIUM RATE OF INTEREST
2. NATURAL RATE WHICH IS DETERMINED AT THAT POINT WHERE TOTAL SAVING IS EQUAL TO TOTAL INVESTMENT. ON IS THE NATURAL RATE OF INTEREST

• CRITICISM

1. VAGUE CONCEPT OF HOARDING:-ACCORDING TO KEYNES THE CONCEPT OF HOARDING CAN BE INCREASED OR DECREASED IS WRONG
2. INDETERMINATE’ACCORDING TO IT RATE OF INTEREST IS DETERMINED BY LOANBLE FUND BUT LOANBLE FUNDS DEPEND UPON INCOME AND INCOME DEPENDS UPON INVESTMENT AND LEVEL OF INVESTMENT DEPENDS UPON RATE OF INTEREST. RATE OF INTEREST CAN NOT BE DETERMINED UNLESS WE KNOW THE INCOME AND WITHOUT KNOWING INTEREST WE CAN NOT ESTIMATE INCOME
3. SYNTHESIS OF DIFFERENT FACTORS: SHOULD BE STUDIED SEPARATELY
4. UNREALISTIC ASSUMPTION OF FULL EMPLOYMENT
5. IGNORES THE EFFECT OF INVESTMENT ON INCOME
6. CONCLUSION:- DYNAMIC THEORY WHICH HIGHLIGHT DETERMINATION OF INTEREST WITH THE CHANGED CIRCUMSTANCES.

• COMPARISON
• CLASSICAL THEORY

1. TOTAL DEMAND AND TOTAL SUPPLY OF CAPITAL
2. REAL FACTORS
3. NARROW CONCEPT
4. NEUTRALITY OF MONEY
5. MONEY AS MEDIUM OF EXCHANGE

• NEO CLASSICAL THEORY

1. DEMAND AND SUPPLY OF THAT PART WHICH IS MEANT FOR LOAN
2. MONETARY AS WELL AS REAL FACTORS
3. BROADER CONCEPT
4. MONEY IS NOT NEUTRAL
5. BUT STORE OF VALUE