CONCEPTS OF INTEREST AND CLASSICAL THEORY OF INTEREST

• INTEREST
• MICRO ECONOMICS
• MEANING OF INTEREST
• INTEREST IS THE PAYMENT FOR THE USE OF MONEY OR THE USE OF LOAN ABLE FUND.
• ANATOL MURAD,” INTEREST IS THE PRICE PAID FOR THE USE OF LOAN ABLE FUNDS. INTEREST MAY ALSO BE DEFINED INCOME DERIVED FROM LENDING OF FUNDS.
• GROSS INTEREST :- TOTAL PAYMENTS MADE BY A DEBTOR TO HIS CREDITOR FOR THE USE OF CAPITAL IS CALLED GROSS INTEREST.
• CHAMPAN,” GROSS INTEREST INCLUDES PAYMENT FOR THE LOAN OF CAPITAL,PAYMENTS TO COVER RISK OF LOSS WHICH MAY BE
• PERSONAL RISK OR
• BUSINESS RISK,PAYMENTS FOR THE INCONVENIENCE OF THE INVESTMENTS AND PAYMENT FOR THE WORK AND WORRY INVOLVED IN WATCHING INVESTMENTS,CALLING THEM AND INVESTING THEM

Ø  GROSS INTEREST

Ø  CONSTITUENTS OF GROSS INTEREST:-

1. NET INTEREST: PAID FOR THE USE OF MONEY ALONE
2. BUSINESS RISK: DUE TO UNCERTAINTY IN BUSINESS
3. PERSONAL RISK:-REFERS TO ECONOMIC CONDITION,CHARACTER AND INTEGRITY OF THE DEBTOR
4. REWARD OF MGMT:-
5. REWARD OF INCONVENIENCE

Ø  DIFFERENCE

• GROSS INTEREST

1. WIDE TERM
2. DIFFERENCE IN THE RATE OF GROSS INTEREST
3. DETERMINED AND INFLUENCE BY MANY FACTORS

• NET INTEREST

1. NARROW TERM: IT IS PART OF GROSS INTEREST
2. MORE OR LESS THE SAME
3. DETERMINED BY SUPPLY AND DEMAND

• CLASSICAL THEORY OF INTEREST
• GIVEN BY J.S MILL,WALRUS,MARSHALL AND PIGOU ETC
• IT REGARDS INTEREST A REAL PHENOMENON AND INFLUENCED BY REAL FACTORS AS PRODUCTIVITY,THRIFT AND ABSTINENCE.
• INTEREST IS DETERMINED BY DEMAND AND SUPPLY OF CAPITAL
• SUPPLY OF CAPITAL

1. SUPPLY OF CAPITAL DEPENDS ON SAVING
2. S = Y-C
3. SAVING IS INFLUENCED BY SUCH REAL FACTORS ABSTINENCE FOR CONSUMPTION,WAITING TIME PREFERENCE.
4. S= f ( r)

• DEMAND FOR CAPITAL

1. TO MAKE INVESTMENTS
2. INCREASE IN PRODUCTIVITY
3. WILL CALCULATE MARGINAL PRODUCTIVITY OF CAPITAL BY KEEPING OTHER FACTORS CONSTANT.
4. DEMAND FOR CAPITAL OR INVESTMENT IS AN INVERSE FUNCTION OF RATE OF INTEREST.

Ø  DETERMINATION OF THE RATE OF INTEREST

• RATE OF INTEREST IS DETERMINED WHERE THE DEMAND FOR MONEY AND SUPPLY FOR MONEY IS EQUAL.

RATE OF INTEREST IS 3% WHERE DEMAND AND SUPPLY ARE THE SAME

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• CRITICISM

1. EQUILIBRIUM BETWEEN INTEREST AND SAVING IS BROUGHT BY RATE OF INTEREST BUT ACCORDING TO KEYNES IT IS BY CHANGE OF INCOME NOT BY RATE OF INTEREST.
2. BASED ON REAL FACTORS ONLY
3. UNREALISTIC ASSUMPTIONS OF FULL EMPLOYMENT
4. NARROW MEANING OF SUPPLY OF CAPITAL: WRONG ASSUMPTION OF SAVING OUT OF CURRENT INCOME

1. INDETERMINATE THEORY:-ACCORDING TO IT RATE OF INTEREST DEPENDS ON SAVING OR TO KNOW THE RATE OF INTEREST,VOLUME OF SAVING MUST BE KNOWN

1. DO NOT CONSIDER BORROWING FOR CONSUMPTION
2. NEUTRALITY OF MONEY: CHANGES IN THE SUPPLY OF MONEY AND CHANGES IN THE DEMAND FOR MONEY DOES NOT HAVE EFFECT ON THE DETERMINATION OF RATE OF INTEREST IS WRONG ASSUMPTION
3. NOT A REWARD OF SAVING ONLY. INTEREST IS REWARD FOR PARTING LIQUIDITY.