level.

10. Cash Balance Approach by Cambridge

1. Introduction : The Fisher's equation considers only the medium of
"exchange as function of money. But Prof. Keynes, Pigou, Robertson and otlher
money.
Cambridge economists have also considered the store of value as function of
According to these Cambridge economists, these changes in the cash balance
influences the price level.
2. Theory (Principle) : If the demand of cash balance increase then price
Ievel decrease and value of money increcase. If the demand of cash balance decrease
othen price level increasc and valuc of money decrcasc.
3. Meaning of Cash Balance Thc cash balance is defined as fixed
: a
et
proportion of caslh balances lheld during specific time period. "Generally people keep
certain amount of caslh balance wvitlh them. Higlh casl balances reduce tlhe cost and this
reduces the prices and increases the value of mnoney. There is a diference of opinion in
-Case factors affecting the casl balances."
of

According to Pigou "Cash balance depends upon tlhe level ofincome. If the
income is low then tlhe amount of casl balances would be less."
Marshall is of theopinion that cash balance depends upon the wealth with
the people. If perSon possess more wealtih then the amount of caslh balance
will be more and less in the reverse case.
30 Kumar Macro Econom

According to Prof. Keynes "TIe anount of cash balance depends

incone with the people, monetary Iabits, format of industrial organiza
and other variables".
4, Purpose of Cash Balance : According to Prof. Keynes people dem
cash in hand due to the following reasons :
(1) Transactionnotive :The income is received at the regular timne interva.
during the entire period certain funds are required to satisfy the regular transactig
The amountof caslh balance depends upon the time interval. Longer the time inten:
grcater funds will bedemanded - for cash in lhand. E.g. if the service class peoples
monthly íncome then they have to keep certain funds for the whole month. If
farner gets, by annually or annual income reccipts then he has to worry abour
month or a full year. Thus longer the interval, reater will be the demand for cast
hand.
(2) Precautionary motive: People have to keep
certain funds to satisfy
contingency demand or unforescen expenditure like sickness, accidents ctc. T
K
demand depends upon nature of income, social structure and
institutions bear the responsibility then the risk reduces
other factors. If
and demands for such fun
reduce. n the developedcountries mnost of the medical expenses are reimbursed byt
companíes so the need for such purposes reduces. In
very few companies provide the underdeveloped count
such facility so people have to keep more
to meet these expenditures. fund with th
(3) Speculative motive :
The demand for speculative purpose alsO
important factor. order to get is
in
purchase and sell shares
the advantages of rising share
prices people pree
in the open market.This requires
satisfysuch transactíons. They
purchase the shares when
the additional funds
when prices are on peak, prices arelow and sel
They get the financial
reverse sítuation
they sell the shares in the market.gain out of this oneration. I0
5. Different Equation of Cash
money has got a positive Balance: The casl balance and valu
relationship and cash
relatíonship. balance and price
level has neg ke
Cash balance
approach can be written as =
income, P= Pricelevel, PY= nominal national Md KPY in which, Y real nati is
íncomethat people want to hold money income, K = of
nort
in the proportion o
withpu
money and
Now for Md
the
must equal, It is
achievement of market
the anount of money
mones
ímportant to note equilibrium, demand
is determined bythe monctary thatthe supply of money for 'gient
cquílibrium inthe money policies of is exogenousiy Thus
market : (i)
M = the central bank of a
(ii) Md= KPY .: country*
Md and
M= KPY tota
1-Money and National Income 31
In which K is related tovelocity
circulation of ioney in Fishers transaction
of V

approach. Thus, when agreater proportion of nominat ineone held in the form of
money (when K is higher) V falls. On the otber hand, when lens proportion of nomina

income is held in money V

rises. In this situationK. By rearranging the above
equations,
1 M
P
KY
KR
(1) Prof. Pigou's Equation :P= In which P value of money. IP is defined
M
M
as price levcl, then the cquation is P =
n.
KR'
P= Average price level of the consumer goods, M= Total proportion of money.
R= Real income of society, K = Part of Real income kept in cash balance.
llustration: SupposeM= 1000 in a society. Total real incone is 500kg. wheat lf
K= then find P

M 1000
P= KR
500

Suppose in the sane exanple ifthe valucof K is reduced to hen the value
of P would be as follows.

E
P
M .. P
1000
.Pe4
KR
500
2
Prof. Pigou hasgiven another equation by considering bank money.
M +
P= KR lC h(1- C))

Inwhich, Share of kept in band as legal rmoney and (! -C) = Share of K

C K

kept as bank deposit, h = Proportion of cash, money of bank.

(2) Keynes Bquation : The equation by Keynes is similar to that of Pigou. This
is presented as :

P
K
In which, N
Total proportion of money.
Price of a unit wich represent
P
K consumer
the average price.
Part of good unit kept in cash form.
Here keynes notificd K to show real income moneykept in
hand by people, not
totalreal money income.
32 SKumar Macro Economic

The real cash balance refer to the amount of bank money kept in form
of
:

in hand by the banking system. Keynes has given the following equation
of N, P and K is given above.
N=P (K + rK') in which meaning
K'= Consumable unit kept in form of bank deposit and r =Liquidity propori
of bank. There are many limitations of the theory by Keynes.
(1) It explains only consumer items.
(2) The relationship between N and P is not so precise. This
type
run.
relationship is obscrved only in the long rule but: not in the short
6. Limitations of the Cash Balance Approach
to know th
(1) Dillicult to know thc amount of cash balancc: It is difficult
amount of cash balances. The theory has given more importance to the cash
balance
are many factors influenci
but this includes the cash balance with everybody. There
the cash balances. It is difficult to know the amount of it.
(2) Not Complete The theory is not a complete theory. It fails to
: explain th
reasons of business cycles or peak and depression.
(3) Indeterminacy:The depcndency and independency is a matter
orproble
in this theory. Which factor is exogenous or independent and which is dependent
is

matter of problem. Price level affccts the demands for cash in hand and demand
fc

cash in hand also affects the price level.

(4) Not valid in the dynamic economy:When the economy is dynamic, prie
change frequently. The theoretical relationship is not maintained. In the short
perio

the relationship betwcen price and cash balances is not maintained. In the long n
thevaluc of K and R willnot remain constant. The other factors also changed in t
dynamic structure.
(5) Over simplificd :The theory is over simplified presentation of the econo
activity. In real structure the value of money is determined by many factors like pes
deprcssion, saving, rate of interest and marginal efficiency of capital. Whcn he
factors are considercd, the thcory becomes more complicated.
(6) Similar with Fisher's thcory : According to Prof. D. H. Robertson, "Pigo
theory is very much similar to that of Fisher. It is almost like a carbon copy.
(7) Fails to cxplain real factors: According to Prof. D. II. Robertson, the the
fails to explain the role of money and capital market in the economy. Moncy
capital market are integrated and that is why it must be explained.
11. Comparison of Fisher's and Cambridge's Equation
1. Introduction : Theexplanation of the Fisher and Cambridge is nac
a different way considering different viewpoints. Economists think that
prescntation by both issimilar but thc other group of economistsview differently.
think that Cambridge equation is obviously more superior to Fislher's theory.
 Money and National Income 33

2. Meaning : The equations given by authors are as follows.

Fisher Where,
=
MV PT M= Stock of mnoney P= General price level
V=Velocity of money T =Total transactions
Cambridge Where,
M= Money stock P=Prices of consurmer goods.
K= Cash balances. R= Real income
The Cambridge equation was given by, Pigou, Robertson and Keynes.
3. Similarities : Most of the economists argue that there is no difference
between Fisher and Cambridge equation. They are very much similar. It is possible to
derive the other equation from onc cquation to the other equation.
MV = M
Fisher's cquation P= T
Cambridge's equation P KR
S

Similarity :
(1) Both of them indicate the general price level.
(2) The money stock M is also similar.
(3) T represents total transactions where as R represents the consunable real
income. There is no remarkable difference in this case.
(4) The Fisher and Cambridge equation represents V and K, which convey
similar neaning. When in inflation vclocity of circulation increases the
dermand for cash in hand reduces. Thus V and K are inverscly related.

Vand are inversely related K=

K
or v K
(5) Fisher cquation has explained the vclocity of money whereas Cambridge
economists have explaíned the income velocity.
(6) Both the equatíons explains that the other factors do remain constant and
there is a positíve relationship between money supply and price level.
(7) Both the equations tries to explain the short term relationship. However
they actually explains the long run relationship. This means that they
conmits the same mistake. The cquation can be casily changed into the
different forinat as follows.
MV M
Fisher's cquation

Piypu's equation P
P

P
M
PT MV
KK
Thus there is a very minor difference between fisher's cquation and
Cambridye's cquation.
 1 Money and National Income
(2) Moreprogressive :In thcFisher's equation
the relationship betweenM and
pis doubtful, but there is no doubt in the Cambridge equation. Fisher considers direet
and proportionate relation between M and P but no such specific relationship is
explained by Cambridge cquation. Iit is true that when money supply changes it leads
to changes in cash balances and production in the economy. Thus its effect on price
is uncertain. Thus Cambridge cconomists consider the progressive factors in
determining valueof money. The cquation is not static but dynamic.
(3) Explains the changes in priccs: The equationexplains reasons behindthie
changes in the price level. Fisher equation only shows the price level but fails to cxplain
the reasons behind this. Pigou tires to explain it with the help of demand for cash
balances. i.e. K.

Moncy is round and lat : Fisher considers only nedium of exchange

(4)
function of money and measurement of value where as Carnbridge school considers
the store of value and standard for deferred paynent. Thus Cambridge equation is
more realistic. The money is flat and round too.
(5) More realistic :Cambridge equation is more realistic due to many reasons
:
given below
(4) Fisher considers only transactions but Cambridge school considers
national income and employment.
(B) Fisher's equation is more mechanical in nature. Cambridge equation
considers the psychological factors. Fisher regards only the mechanical and
institutional factors whereas Cambridge school emphasison psychological
factors.
(C) According to Fisher money supply do not affect V and T which is wrong
assumption. Here Cambridge equation remains realistic.
(6) Reasoning: Fisher only shows the relationship between money supply and
prices but fails toexplain reasons behind it. The Cambridge school explains it with the
help of demand for cash balances.
(7) Explains the cyclical changes : Fisher's equation fails to explain the reason
behind the cyclicalchanges in the economy when money supply is constant e.g. In the
depression whenprice falls it is due to rise in the demand forcash balances. People
prefer to keep more money with them and demand less. This reduces the prices. On
the other hand in inflation people spend more and this reduces the demand for cash
balances. Such changes are explained in terms of income and thus proved to be mote
useful.
6. Criticism of Cambridge Equation : It is true that the Catnbridge equation
isSuperior to Fisher's equation but it is not free from criticisns. The linitations are as
follows:
 36 Kumar • Macro Econ
: econ
() Fails to explain the complex cconomic behaviour The
benaviour is fairiy complex in nature. The simplification of the theory prevenm
expiain the complex behaviour. A. C. L. Day is of the opinion that Cambridge eaut
is superior toFisher but it is not a perfect monetary equation. It is simple but aj
expiain the complex economic behaviour.
(2) Speculative demand is ignored : The Cambridge equation has
considered the demand for the speculative motive.
(3) Difticult to know cash balances : It is necessary to identify the
balances but in actual practice at the nacro level it is difficult to know the a
amount of cash balances. It is also difficult to know the changes in the real
balances.
(4) Effect of money supply : When money supply becomes an indepen
variable itgives two effects on production and on price level. It is difticultto ide
these effects.
(5) Whodetermines ? What ? :In many cases the independent and depen
variables are not watertight. Money supply and prices are inter dependent varia
There is no specific cause effect relationship between them.
12. National Income : Meaning and Concept
1. Introduction : National income is a basic concept of micro econom
any country, national income is used as a measuring
rod for economic prosper
the country. The efforts made by Alfred Marshall, Irving Fisher and Prof. A.C.Pig
clarify the concept of national income. It is also necessary to
understand the co
of national product to clarify the concept of national income.
2. The meaning of National income: In any
one year, the net total of market value
countr, during the per
of commodities and services, mater
immaterial, produced with the help of capital,
labour and natural resources is
national income.
Two things are considered to find out
the national income :
(I) The commodities and services
monetary value. Therefore, only commodities produced in the country
mus

are included in it. Because and services which have a markel

of this reason, the household work of housewite
included in it.
(2) To measure the exact
national income, the final value of commodit
service are not considered. Income a
is flow, where wealth is a
wealth is utilised by capital and labour quantity. e
and commodities and services are p
which is known as national income.
Generally, a coin has twO side,
but nation income is a coin with three -