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Cash balances Quantity theory of money

Cash balances Quantity theory of money

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This write up is useful for Graduates in Economics
This write up is useful for Graduates in Economics

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Published by: Appan Kandala Vasudevachary on Feb 15, 2011
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Lesson 14: Cambridge Equation
Objectives:
After studying this lesson, you will be able to understood,
The importance of demand for money
The Cambridge approach to demand for money
Marshall equation
Pigou’s equation
Robertson’s equation13.1 Introduction13.2. Cambridge approach to demand for money13.2.1. Marshall Equation13.2.2Pigou’s Equation13.2.3Robertson’s Equation13.3 Summary13.4 Check your progress13.5 Key concepts
 
13.6 Self Assessment questions13.7 Answers to check your progress13.8 Suggested Readings
13.1 Introduction:
The present lesson is concerned with the one of the approaches to quantity theory of money i.e., Cambridge quantity theory of money. As you aware, the quantity theory of money is, indeed, a very old theory. It was first propounded in 1588, by an Italianeconomist, Davanzatti. Later, the classical economists explained the value of money interms of the quantity theory of money. The quantity theory of money aims at explainingthe factors that determine the general price level in a country. In other words, it pinpointsthose causes which bring about changes in the value of money. In its unrefined form, thetheory states that the price level or the value of money is determined by the supply of money. The value of money, according to this theory, varies inversely as the supply of money; the price level, on the contrary, varies directly as the quantity of money.
13.2. The Neo-classical quantity theory of money or Cambridge Equation:
 Neo-classical quantity theory of money also known as ambridge cash balance theory of demand for money, because it was put forward by Cambridge economists like Marshall,Pigou, and Robertson. It places emphasis on the function of money as a store of value or wealth instead of Fisher’s emphasis on the use of money as a medium of exchange.Marshall, Pigou and Robertson focussed their analysis on the factors that determineindividual demand for holding cash balances. Although, they recognised that currentinterest rate, wealth owned by the individuals, expectations of future prices and futurerate of interest determine the demand for money, they however believed that changes inthese factors remain constant or they are proportional to changes in individual’s income.
 
Thus, they put forward a view that individual’s demand for cash balances is proportionalto the nominal income. Thus, according to their approach, aggregate demand for moneycan be expressed asMd = kPY ------------(1)Where Y=real national income; P = average price level of currently produced goods andservices; PY = nominal income; k = proportion of nominal income (PY) that people wantto hold as cash balancesDemand for money in this equation is a linear function of nominal income. The slope of the function is equal to k, that is, k = Md/Py, thus important feature of cash balanceapproach is that it makes the demand for money as function of money income alone. Amerit of this formulation is that it makes the relation between demand for money andincome as behavioural in sharp contrast to Fisher’s approach in which demand for moneywas related to total transactions in a mechanised manner.The Cambridge economists have attempted to express the relationship between thesupply of and the demand for money by formulating cash balance equations known as‘Cambridge Equations’. We shall discuss now some of the important equations.
13.2.1 Marshall’s Equation:
The Marshallian cash balance equation is expressed as follows:M = KY ----------------(2)Where,M is the quantity of money,

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