Question

State Cambridge equations of the value of money.

Answer 1

Cambridge Approach (Cash Balances Approach):

1. Marshall’s Equation:
The Marshall equation is expressed as:
M = KPY
Where
M is the quantity of money Y is the aggregate real income of the community. P is Purchasing Power of money
K represents the fraction of the real income which the public desires to hold in the form of money.
Thus, the price level P = M/KY or the value of money (The reciprocal of the price level) is 1/P = KY/M
The value of money in terms of this equation can be found out by dividing the total quantity of goods that the public desires to hold out of the total income by the total supply of money. According to Marshall’s equation, the value of money is influenced not only by changes in M but also by changes in K.

2. Keynes’Equation
Keynes equation is expressed as:
n = pk (or) p = n / k
Where
n is the total supply of money p is the general price level of consumption goods
k is the total quantity of consumption units the people decide to keep in the form of cash, Keynes indicates that K is a real balance, because it is measured in terms of consumer goods. According to Keynes, peoples’ desire to hold money is unaltered by the monetary authority. So, the price level and value of money can be stabilized through regulating the quantity of money (n) by the monetary authority.
Later, Keynes extended his equation in the following form:
n = p (k + rk’) or p = n / (k + rk’)
Where,
n = total money supply p = price level of consumer goods
k = peoples’ desire to hold money in hand (in terms of consumer goods) in the total income of them
r = cash reserve ratio
k’ = community’s total money deposit in banks, in terms of consumers goods.
In this extended equation also, Keynes assumes that k, k’, and r are constant. In this situation, price level (P) is changed directly and proportionately changing in money volume (n).