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GROUP 6.
QUANTITY THEORY OF MONEY : CASH BALANCE APPROACH
- What is Cash Balance approach? Cash-balance approach states that the value of money depends upon the demand for money and the demand for money arises on account of its being a store of value.
- Define the Co-efficient ‘K’. K represents that fraction of total national income (R) for which people wish to keep cash.
- What is mean by unitary elasticity of money demand function? K, R, c and H are taken as constant in Pigou’s equation and the equation gives a unitary elastic demand function for money. It states that halving of purchasing power of money leads to the doubling of the demand for money and vice-versa.
- Why is Cambridge Approach psychological? The Cambridge Approach is considered as Psychological because it studies the psychological factors which influence ‘k’.
- What does ‘K’ mean in Marshall’s equation of Cambridge cash balance approach? The portion of money income that the people intend to hold in the form of cash.
- State and Explain the Cash Balance Approach to money and price.
Some Cambridge economists led by Dr. Marshall, popularized and adhered to a slightly different version of the quantity theory of money, known as the cash balance approach, on account of its emphasis on cash balance. According to cash-balance approach, the value of money depends upon the demand for money. But the demand for money arises not on account of transactions but on account of its being a store of value. It is, thus, the demand for ‘money sitting’ rather than money ‘on wings’ that matters. It may, however, be made clear that in determining the amount of these cash balances the individuals and institutions are guided only by their real value. Thus, an individual is concerned with the extent of his liquid command over real resources. The community’s total demand of money balances constitutes a certain proportion of its annual real national income which the community seeks to hold in the form of money. The community’s demand for real cash balances in this sense varies from time to time. Thus, given the state of trade (T) and the volume of planned transactions over a period of time, the community’s total demand for real money balances can be represented as a certain fraction (K) of the annual real national income (R). The following lines from Marshall explain clearly the substance of the cash-balance version of the quantity theory, “In every state of society there is some fraction of their income which people find it worthwhile to keep in the form of currency; it may be a fifth or a tenth or a twentieth.” Holding of money involves a sacrifice because when we hold, we spend less. To have too little holding of money may mean inconvenience, to have too much may mean unnecessary
To this extent the approach is similar to Fisher’s, but the emphasis is on want to hold, rather than on have to hold. This is the basic difference between the Cambridge monetary theory and Fisher’s framework. The essence of this theory is that the demand for money, in addition to depending on the volume of transactions that an individual might be planning to undertake, will also vary with the level of his wealth, and with the opportunity cost of holding money, the income foregone by not holding other assets.
Comparing Cash Transaction approach with Cash Balance approach of
quantity theory of Money.
Cash Balance approach is regarded as superior to the cash transaction approach on the following grounds: The cash balances equation brings to light the demand for money to hold. This emphasis on the demand side is in sharp contrast with traditional emphasis on the supply side. Actually, the Cambridge equation was put forward to validate the classical quantity theory of money according to which the supply of money is the sole determinant of the price level. The cash balances approach links itself with the general theory of value, since it explains the value to money in terms of the demand for and supply of money. The equation P = M/KT is a more useful device than the transaction equation P = MV/T , because it is easier to know how large cash- balances individuals hold than to know how much they spent on various types of transactions.
The cash balances approach has given rise to the famous liquidity preference theory, which has become an integral part of the theory of income, output and employment. Cash balances approach brings out the importance of k. An analysis of the factors responsible for fluctuations in k offered scope for the study of many important problems like uncertainty, expectations, rate of interest etc. which are not considered in the transactions approach. The symbol k reflects the desire for liquidity. A shift in k in the direction of an increased desire for liquidity shows a fall in demand for goods, i.e., a movement away from goods to money resulting in the revision of production plans, curtailment of output and fall of income.
similarities and dissimilarities between cash transaction approach cash
balance approach.
There are similarities and dissimilarities between the two approaches of the quantity theory of money, i.e., the Fisherian transaction approach and the Cambridge cash-balance approach. The two approaches have the following similarities: 1. Same Conclusion: The Fisherian and Cambridge versions lead to the same conclusion that there is a direct and proportional relationship between the quantity of money and the price level and an inverse proportionate relationship between the quantity of money and the value of money.
2. Similar Equations:
3. Relative Stress of Supply and Demand for Money: Fisher’s approach stresses the supply of money, whereas, the Cambridge approach lays more emphasis on the demand for money to hold cash. 4. Definition of Money: The two approaches use different definitions of money. The Fisherian approach emphasizes the medium of exchange function of money, whereas the Cambridge approach stresses the store of value function of money. 5. Nature of P : In both approaches, the price level (P) is not used identically. In Fisher’s version, P is the average price level of all goods. On the contrary, in Cambridge version. P refers to the price of consumer goods. 6. Factors Affecting V and K: Fisher is concerned about the institutional and technological factors governing how fast individuals can spend their money (i.e., V). The Cambridge School, on the other hand, is concerned about the economic factors determining what portion of their wealth the public desires to hold in the form of money (i.e., K). 7. Relationship between M and P : The Fisherian approach maintains that any change in the money supply produces proportional changes in the price level. This is because Fisher believes that both velocity and real income are in the long run independent of each other and of supply of money.
In the Cambridge approach, the price level may change by more or less than the money supply; it depends upon what happens to the stock of non-monetary assets and their expected yields on which the Cambridge economists believed the desired cash balances depend.
8. Different Approaches to Monetary Theory: Both Fisher and Cambridge School led to the development of two different approaches to the monetary theory. Fisher’s approach has given rise to an inventory theory of money holding largely for transactions purposes. On the other hand, the Cambridge approach has been developed into portfolio, or capital theoretic approach to monetary demand.
