Unit 2

DEMAND FOR MONEY

VALUE OF MONEY
Introduction - The concept of value of money is used in economics to mean value in
exchange. Under the barter system the exchange value of a good is expressed as the
quantity of other goods which must be exchanged to obtain one unit of the given
good. The marginal utility theory holds that the exchange value of an economic good
depends upon the utility rendered by the last unit of the good consumed thus
combining the concepts of desirability and scarcity.Money is different as it does not
provide direct utility and is not demanded for its own sake. The demand for money is
a derived demand, it is solely derived from its exchange value.

Value of money means the purchasing power of money, the ability of each unit to
command goods and services in exchange. All that can be purchased with a unit of
money is the value of money.
The value of money cannot be determined in terms of a single commodity or a
group of commodities. It should be expressed in the form of all commodities that
can be purchased by it.It refers to the general purchasing power of money ie the
amount of goods and services in general which a unit of money can purchase at a
particular time. According to Robertson “ we mean the amount of things in general
which will be given in exchange for a unit of money”

The larger the quantities of goods and services which a unit of money can buy the
higher is the value and vice-versa. Therefore the value of money is closely related
to the price level .Value of money varies inversely with the price level. Higher the
price level lower is the value of money and vice-versa. Algebraically Vm=1/P

Since money can buy anything that has a price ,the value should be expressed in
terms of all commodities.But there is a practical problem as it is not possible to
express the value in terms of innumerable goods.This problem is overcome by
taking the general price level . A rise or fall in the general price level does not mean
that the price of all goods has risen or fallen in the same proportion. It just means
that in general the prices of goods and services has risen

The concept of general price level is beset with some practical difficulties. The
general price level is based on the price level of a variety of goods which has little
relevance to an individual who is at a particular point of time interested only in a
collection of goods that give him utility.The purchasing power of his money is
affected by the prices of only those goods and services . He will reckon the value
of his currency in terms of the prices of only those goods he buys. Thus the value
of money is not the same for all individuals.

Monetary theory often focuses on the relationship between quantity of money and
price level and ignore changes in the real variables.
Crowther believes that there is an infinite number of different values of money
is .according to the uses to which it is put .According to him any exact definition
of the value of money is difficult.To overcome these problems Crowther
distinguished three standards of value . They are

1. The wholesale standard

2. The retail standard and
3. Labor standard.
Demand For Money
Meaning- The demand for money within a specified area at a given time is merely
the sum of individual demand for money. Since aggregate demand for money is
the sum of individual demand for money it is necessary to examine why people
demand money.

People demand money because it serves as a medium of exchange . Therefore a

major element of the demand for money is the transactions demand for
money.Another reason why people demand money is because it acts as a store of
value.people hold money in excess of what is required for transactions purposes
because its general acceptability, liquidity and security. The concept of demand
for money has been interpreted in different ways depending upon the motives for
holding money
Classical View of Money
Classical view money is not demanded for itself provides no direct utility to its
holder. It is demanded because of its purchasing power. It can be used to buy
goods and services which provide utility to the consumer. Demand for money is a
derived demand.Money is demanded for transactions purposes only. Money is an
intermediary that facilitates exchange. Classical economists believed that the
demand for money was determined by the total volume of goods and services that
had to be paid for during a given period of time.The aggregation of items offered
in exchange for money is referred to as transactions and the amount of money
demanded by the people for these transactions is the transactions demand for
money.

They believed that the demand for money was determined by objective factors
They believed that the demand for money at any given time can be expressed as
the amount of goods and services that will be purchased with money during a
specified period of time.therefore the magnitude of trade that determined the
demand for money.A high proportion of trade in any given period depends upon
the production, transportation and merchandising of currently produced
goods,securities and services. This in turn depends upon the quantity and quality
of the factors of production and the techniques of production. Other factors like
the degree of employment of factors of production, velocity of circulation of
money,the volume of new security issues, volume of goods and securities carried
over from the previous periods etc.Therefore the demand for money is likely to be
higher in developed than in under-developed countries.

Demand for money depends upon the volume of currency in circulation and the
velocity of money in circulation.
The classical concept of demand for money is based on the idea that money is
neutral. Neutrality of money means that changes in the money supply will affect
only the nominal variables like prices, wages and the exchange rate and not the
real variables like output, employment, real interest rates and real
wages.Classical analysis of demand for money was within a static equilibrium
framework.In such an analysis there is perfect synchronisation between income
and expenditure flows ans therefore the asset demand for money was not
considered by the classical economists.

Keynesian Liquidity Preference Theory -According to the Cambridge economists

like Marshal, Pigou, Robertson along with Keynes conceived the demand for
money in the context of the store of value function of money. Money is not merely
to be spent, it ca he held in the form of an asset or wealth which can be easily
converted into any other form of wealth at any time.The demand for money
means demand for money balances.
People choose to hold money balances in preference to other forms of wealth
because of some special qualities of money-its general acceptability in payments,
its perfect liquidity and its safety . Money is demanded for its own sake.

According to Keynes the three motives for liquidity preference( the desire for cash
or money balances) are 1) Transactions motive 2) precautionary motive and 3)
speculative motive

1. Transactions Motive is the need for cash to carry out currennt pf transactions
of a personal and business nature. This demand focuses on the medium of
exchange function of money, People desire to hold a certain amount of
money to carry out their everyday transactions which are of a routine nature.
In practical life money is received in discrete intervals of time while payments
have to be made at frequent intervals for the purchase of goods and
services.the lack of perfect synchronisation between receipts and
expenditure leads people to maintain a cash balance at all times
According to ACL. Day the transactions demand for money is based on two
characteristics of money namely convenience and certainty, convenient because
of its general acceptability and certain because in normal times the prices of
goods and services expressed in terms of money generally tend to be more stable.
The transactions motive is split up into a) the income motive and b) business
motive

Income motive refers to the transactions motive of the consumers. This motive
depends upon several factors namely 1) the size of the income 2) the interval
between income receipts and payments. The business motive refers to the
transactions demand of the business community. Business enterprises need cash
to purchase raw materials, pay salaries and wages and meet other current
expenditure.The larger the turnover of the enterprise greater will be their
transactions demand
For the community as a whole the transactions demand for money will depend
upon 1) the size and timing of personal income and 2) the turnover of
business.The transactions demand for money is income determined and is
relatively stable Also variations in the rate of interest have no influence on the
transactions demand for money.

2. The Precautionary Motive- Besides holding money for transactions purposes

people also desire to hold money as a precautionary store of wealth to meet some
unforeseen contingencies.All prudent individuals and businesses desire to hold
money balances in order to be prepared to meet some unexpected emergency.The
amount that a community holds for this purpose depends on the level of income
received and hence is income determined.The amount held for this purpose also
depends upon the level of uncertainty perceived
3. The Speculative Motive- Keynes was the first to introduce the concept of the
speculative demand for money.People want to hold money as a store of value or
wealth. By the speculative demand for money arises because of the uncertainty
regarding the future rate of interest.Once the future rate of interest is uncertain
people have an opportunity to speculate in the hope of securing profit from
knowing better than the market what the future will bring forth.By uncertainty
Keynes did not mean uncertainty in the mind of the individual wrt the movement
of the rate of interest,just differences amongst individuals as to the movement of
the rate of interest. Money held as speculative balances represents a store of
value . a liquid asset which the holder intends to use for making speculative gains
out of the purchase and sale of securities at the right moment. To Keynes people
make capital gains by speculating in the bond market . it is through the bond
market that the prices of fixed income yielding assets are affected and hence rate
of interest changes. There is an inverse relationship between bond prices and rate
of interest
The speculative demand for money is a function of the rate of interest . The
speculative demand for money is income determining.

Determinants of the Demand for Money Keynes has represented the aggregate
demand for money by M which is composed of M1 and M2. M1 is the amount of
cash held for transactions and precautionary purposes and M2 is the amount of
cash balances held to satisfy the speculative motive.Corresponding to M1 and M2
are two liquidity functions L1 and L2. L1 is the liquidity function corresponding to
income Y which determines M1. Therefore M1=L1(Y).L2 is the liquidity function of
the rate of interest r which determines M2. Therefore M2 = L2(r)
Diagrammatic Representation of the Transactions and Precautionary demand for
Money
The demand for speculative balances is a function of the rate of interest . It is highly
interest elastic.Higher the rate of interest lower will be the speculative demand for
money and vice-versa.This is because of the inverse relationship between bond
prices and rate of interest. At a very low rate of interest it becomes perfectly elastic
as indicated by AB in the figure.This is known as the liquidity trap and can be defined
as a set of points on the liquidity preference curve where the % change in demand
for money in response to a % change in r is infinity.The liquidity trap rate of interest
is thus the aggregate critical rate of interest at
which the the speculative demand for money becomes
perfectly elastic.At this rate of interest wealth holders
Prefer to hold their entire assets in the form of money
because the opportunity cost of holding money in the
form of interest income foregone is very small.Any
Increase in money supply will be held as cash balances
And thus shows the ineffectiveness of monetary policy to increase investment
and employment at low rates of interest.This is because the wealth holders begin
to regard money as a perfect substitute for interest bearing bonds at the minimum
critical rate of interest.

Total Demand for Money-is a composite demand made up of the transactions,

precautionary and the speculative demand for money

Thus M= f( Y, r) or M = M1 + M2 = L1(Y) + L2(r).Thus the total demand for money

varies positively with the level of income and inversely with the rate of
interest.There will be a particular quantity of cash that which the public will want
to hold for any given combination of income and interest rate. How much money
is demanded by the public at each combination of income and interest rate will be
determined by several factors .
Prof Chandler has given several important determinants of money supply.They are

1. The nature and variety of substitute assets. If other assets available for
holding are highly risky and not liquid, the demand for money is likely to be
high.
2. The ease and certainty of security credit. People will like to hold larger money
balances if credit is not available easily or when its availability is uncertain.
3. The wealth of the community. The richer the community the greater will be
the demand for money and vice-versa.
4. The system of payments in the community. The demand for money is
affected by the frequency,regularity and correspondence between time and
amount of money receipts and disbursements.the greater the frequency and
regularity of disbursements and payments, the smaller is likely to be the
quantity of money demanded The greater the transactions greater will be the
demand for money
5. Expectations as to future income receipts. People will increase thei r demand
for money balances when they fear that their future income receipts will be less
certain and likely to decline.

6. Expectation regarding prices. People will tend to hold more money balances
when they expect prices to fall. This is because in such a situation their
purchasing power will increase and the value of goods will depreciate relative to
money.

Thus all factors which tend to increase the velocity of circulation of money have
adverse effects on the demand for money. The behaviour od interest rates and the
level of income within an economy depend upon several factors which can be
summarised in four functions namely a) the consumption function and the saving
function b) the investment function c) the money supply function and d) the
demand function.
QUANTITY THEORY OF MONEY
Introduction How is the value of money determined? Why does the value of money
fluctuate? These are questions which have for a long time occupied an important
position in monetary theory. Approximately in the order of their historical
development, the various theories of the value of money are
1. The Commodity Theory
2. The State Theory
3. The Quantity Theory and
4. The Income theory
The Commodity theory states that money is essentially a commodity like any
other commodity and its value is determined supply and demand-the cost of
producing it and the desire people have for it in its non monetary value. The
monetary value was the commodity value eg gold standard
The State theory of value says that the value of money lies exclusively in the laws
that create and govern it.Money is what people are willing to accept and the state
can increase the willingness in this respect.The state may be the instrument
through which the quantity of money can be regulated and hence the value of
money.

The Quantity theory is one of the most important theories which seeks to explain
the determination of the value of money at any time and the variations of this
value over periods of time. This is one of the oldest theories to have influenced the
views of economists at some point or another.This theory seeks to explain
changes in the value of money in terms of changes in the quantity of money.John
Locke was the first gave a clear formulation of the quantity theory in 1691. Later
David Hume elaborated on this in 1792 in his Political Discourses. There are two
approaches to the quantity theory of money. They are
 1. The Transactions Approach /Fisher’s Version and
2. The Cash Balance Approach /Cambridge Version

Transactions Approach : In its crudest form the QTM states that the value of
money is dependent upon the quantity of money in circulation or in other words
the price level is a function of the quantity of money.The earliest version of the
QTM established a direct relationship between the quantity of money and the
price level such as an increase in the former always induced an increase in the
latter and vice versa

The transaction version of the quantity theory explains that other things remaining
unchanged, the changes in money supply bring about a directly proportionate
change in the price level and hence an inversely proportionate change in the
value of money.
J.S. Mill “ The value of money, other things being the same,varies inversely as its
quantity,every increase lowers the value and every dimunition raising it in a ratio
exactly equivalent.”
Thus the cause of the changes in the value of money lies in the changes in its
quantity. During a given period of time money flows in one direction while goods
and services move in the other direction.In a monetised economy, the value of
these two streams will be equal,for the total volume of money payments will
balance evenly against the total money value of all goods and services sold.
The theory is based on the assumption that the volume of trade remains
unchanged, velocity of circulation of money is constant and there is no change in
the ratio between the cash and credit money.
The Equation of Exchange- Irving Fisher an American economist presented the
transactions approach to the quantity theory of money in his book “ The
Purchasing Power of Money” published in 1911. Fisher presented the theory in
an equation called the equation of exchange .He puts it as
MV = PT or P = MV/T where
M = represents the quantity of money in circulation,both coins and paper currency
but excludes bank reserves and money held by the treasury
V = velocity of circulation of money i.e. the average number of times each unit of
money is spent for the purchase of goods and services during a given period.It is
obtained by dividing the total money payments in a given period by the units of
money in circulation
P = the general price level or the average price per unit of T
T = refers to the aggregate volume of transactions for which money payments are
made. It is equivalent to the physical volume of trade.
Thus the product MV gives the aggregate effective supply of money in a given
period, while PT is the money value of all purchases made during a given period
and hence gives the demand for money.
MV = PT denotes that the supply of money = demand for money. Stated differently
the money in circulation ( M) multiplied by the velocity of circulation of money (V)
is equal to the sum total of traded goods during a given period multiplied by the
price level. This formula is derived from the fact that what is given in payment for
anything in a given period is equal in value to what is sold.The identity lies in the
fact that since for every monetary payment there must be a monetary receipt, the
sum of monetary payments (MV) must be identical to the sum of all receipts (PT).
The equation of exchange is a truism.

The equation denotes that the price level P is directly related to MV and inversely
related to T. In the words of Fisher “ The quantity theory asserts that (provided
will the velocity of circulation and volume of trade are unchanged)if we increase
the number of dollars, prices will be increased in the same proportion.:
The equation MV = PT takes into consideration only currency money and its
velocity of circulation. But in modern economies bank money or credit money
forms a very important part of the money supply in an economy. Therefore credit
money and its velocity of circulation needs to be included as constituents of the
money supply. Therefore Fisher extended his original equation of exchange to
include bank money M’ and the velocity of its circulation V’.Fisher subdivided
money into two components and treated them separately. Thus
MV + M’V’ = PT or P = MV + M’V’
T

Thus the aggregate effective money supply is represented by MV + M’V’. The price
level P varies is directly related to M. M’, V,V’ and inversely related to T. However
the equation of exchange is not the QTM unless certain assumptions are made
regarding the different variables in the equation
Assumptions

1. The price level P is a passive factor or a dependent variable, initiating no

change in other factors in the equation but completely responsive to the
changes occuring in those factors .
2. Total volume of transactions T remains constant. Implicit assumption of full
employment.
3. The velocity of circulation of money V also remains constant.The velocity of
circulation is determined by the system of payments,individual habits,
commercial customs, the stage of development of the system of credit and
finance etc.All these factors change slowly and independently of the money
supply. SInce velocity of circulations depends mainly on the monetary habits
of the people which do not change immediately it is considered to be a stable
phenomenon and is independent of M Same is the case with V’.
The bank money M’ is a function of M. The ratio of M’ to M remains constant

Thus all the variables M”, V,V’ and T are shorn of their fluctuating tendencies. Thus
Fisher is successful in establishing a direct proportionality of P to M
FISHER ‘S

TRANSACTIONS

APPROACH TO THE

QUANTITY THEORY

OF MONEY
Critical Appraisal of the Transactions Theory
The equation of exchange has been used in one form or the other for several
decades. Though outdated the relationship that it shows is true in the modern
world as well . However this theory has been criticised on several grounds.A few
of these are

1. This theory is based on several unrealistic assumptions

2. The theory assumes that T and V are independent of the variations in M and
P. In fact all the variables in the equation are inter-related and it may be
difficult to determine which is the cause and which is the effect.
3. Fisher’s analysis is more relevant to the long run than to the short run.
4. The equation MV= PT is an accounting identity and is a truism. It does not
provide a causal explanation for changes in the value of money.

5. The equation of exchange suffers from certain inconsistencies. M for instance

refers to a point of time whereas V refers to turnover over a period of time.

6. The theory does not throw light on the level of national income as T includes
both final as well as intermediate transactions.

7. The theory assumes the existence of full employment.

8. The QTM is static in nature. It applies to a perid when other things remain
constant. But we live in a dynamic world .

9. This theory fails to explain cyclical fluctuations of prices and production

10. The price level depends several factors not included in the equation like
diversification of industries, facilitation of transportation, differentiation of human
wants etc.

11. Overemphasizes the role of money supply in determining the price level.
Ignores factors like income,expenditure,savings and investment.

12. T refers to total transactions and therefore does not refer to a specific
standard of value.

13. Theory refers to money in circulation but people hold money balances for the
future.Money which is not spent is thus not effective money in Fisher’s analysis.

14. This theory ignores the role of rate of interest as a link between M and P
Income Flow Equation of Exchange
Another variant of the QT is based on the income flow equation of exchange It
restricts transactions to those involving real national income (y) that is the flow of
final goods and services over a period of time excluding intermediate goods To
differentiate the income flow equation of exchange from the transactions
equation subscript y is used for all terms except M

MVy=PyTy or Py= MVy/Ty

CASH BALANCE APPROACH
INTRODUCTION : The transaction approach to the quantity theory had its main
adherents in the USA. An alternate approach evolved in Cambridge, England
known as the cash balance approach.This approach was popular in England and
Europe.This approach is associated with the names of Marshall,Pigou, Robertson
who were Cambridge economists. The transactions approach lays emphasis on
the supply side while the cash balance approach lays emphasis on the demand
side.According to the Cambridge economists demand for money means demand
to hold a stock of liquid cash balances.The transactions approach gives
importance to money as a medium of exchange or what is called “ money on
wings” while the Cambridge approach gives importance to the store of value
function of money or “ money sitting”
Alfred Marshal first examined the concept of cash balances in society. He
suggested that “ in any state of society there is some fraction of their income
which people find it worthwhile to keep in the form of currency” This fraction is
designated as K. K is the proportion of aggregate annual income represented by
the stock of money ie K= M/Y where M is the stock of money and Y is aggregate
national income expressed in monetary terms. K is the index of demand for
money as a store of value . Money according to Marshal is ready purchasing
power .The desire to hold their purchasing power in the form of cash balances is
liquidity preference. The Cambridge economists considered only the transactions
and the precautionary motives for holding money not the speculative motive. The
demand for cash balances K is stated as a fraction of real national income. This
means that a decline in the purchasing power of money will raise the demand for
cash balances. The expression M=KY suggests that the value of money supply is
equal to the value of all other things over which purchasing power is held in the
form of
form of money where Y represents the level of national income and K the
proportion of annual income which people wish to hold in the form of cash. If the
quantity of money supply M is equal to the quantity of money demanded Ky, there
will be no attempt to change the monetary expenditures so as to increase or
decrease the real command over income held in the form of money balances.Thus
prices will be constant and a condition of equilibrium will be attained.

The Cash Balance Equation: The proponents of the cash balance approach have
given algebraic equations known as the Cambridge equations to facilitate the
exposition of their analysis.These equations are also identities and state a truism.

Marshall’ s Equation He was the pioneer of the cash balance approach. His
equation is M=KPY where
M = the quantity of money ( currency and demand deposits
P = price level
Y = aggregate real income and
K = the proportion of real income that people desire to hold in the form of cash
Thus using this equation the value of money (1/P) is determined by the following
1/P = KY/M or P = M/KY. For example if M = 1000 and Y = 10000 and K = 0.5 , then
the value of money will be 5 ie 5 units per rupee of money and the price level will
be Rs ⅕ per unit.
The cash balance approach implies that the price level P is directly proportional to
the money supply M and indirectly proportional to the level of real income Y and
K. A sudden rise or fall in K can affect prices even if the money supply is constant.
For the determination of prices it is K and not M which is more important
Pigou’s Equation

P = KR/M where P represents the purchasing power of money expressed in terms

of wheat. It is the inverse of P the price level. R represents the total resources
expressed in terms of any commodity say wheat enjoyed by the community at any
given period of time. It thus represents the real income .K represents the
proportion of these resources that the community prefers to hold in the form of
titles to legal tender and M stands for the number of units of legal tender or total
money stock

Therefore P ( purchasing power) will vary directly with K or R and inversely with
M.Since money is held by the community not merely in the form of cash but also
in the form of bank deposits Pigou extended the equation by dividing cash into
two parts ie cash with the public and deposits with the bank
 Thus
P = KR /M [ c + h (1-c)] where
c is the proportion of cash which people keep with themselves
1-c is the proportion of bank deposits held by the public and
h is the proportion of cash reserves to deposits held by the banks
Robertson’s Equation -similar to Pigou but with a slight difference. Instead of R
the total resources Robertson includes total transactions T . His equation is
M = KPT where
P is the price level
M is the money supply
T is the total amount of goods and services to be purchased during a year and
K is the proportion of T which people wish to hold in the form of cash. The
equation shows a direct relationship between M and P and inverse one between P
with K and T
Keynes Equation -Keynes was not satisfied with Pigou’s equation and hence gave
his own equation in his book “ A Tract on Monetary Reform” This equation is
known as the Real Balance Equation.Keynes stated that a holder of money
requires a quantity of real balances which is in an appropriate relationship with the
quantity of real transactions upon which those balances are spent. He measured
real balances as consumption units and gave his equation as follows
n = pk or p = n/k where n represents the total quantity of cash, p the price of a
consumption unit and k represents the amount or number of consumption units
the community chooses to hold in the form of cash.k is made up of a collection of
specified quantities of the public’s standard articles of consumption .
To include bank money in money supply Keynes extended the equation such that
n=p(k + rk’) or p = n/k + rk’ where r stands for the proportion of bank’s cash
reserves to their deposits and k’ represents number of consumption units the
community holds in the form of cash.
According to Keynes people are concerned about the value of money with respect
to consumption goods only . Assuming k k’ and r to be constant n and p rise and
fall in the same proportion.

Superiority of the Cash Balance Approach

1. While Fisher’s equation is mechanistic as it does not explain how changes in

money supply bring about changes in the price level. The Cambridge equation
attempts to give the causal factors involved like a change in the k can change
the price level even if money supply remains unchanged. More realistic
2. Since the cambridge approach gives importance to people’s demand to hold
cash balance analysis of K and its determinants widens the scope to study
many important factors such as expectations, uncertainty, interest rate, etc
which were not considered in fisher’s model
3. Cash balance approach gives importance to subjective factors such as human
values which are the basis for all economic activities.
4. The cash balance approach focuses on the level of income rather than the total
volume of transactions.The theory of price determination cannot be studied in
isolation from income and output
5. The element K in the cash balance approach is more significant in explaining
trade cycle fluctuations than V of Fisher’s approach
6. Break from the Fisher’s version as it has shifted the focus from institutional and
technological factors to psychological factors as the main determinants of money
demand.
7. This theory tries to explain the value of money both in terms of the supply and
demand for money though greater emphasis is on the demand for money
8. The cash balance approach has helped the development of the liquidity
preference theory which is very significant in explaining income and employment
determination and also in explaining the limitations of monetary authority to
control crises.

Criticisms of the Cash balance Approach

1.The cash balance equations emphasize the purchasing power of money in

terms consumptions goods only eg Keynes and Pigou. However the value of
money cannot be restricted to consider only consumption goods, since money
buys several other goods and services.

2. The approach is defective because it does not take into consideration the total
demand for money. It considers only the transactions and the precautionary
motive and ignores the speculative motive.One of the most important reasons for
changes in money income is the speculative demand for money, without any
corresponding change in the quantity of money.
3. By ignoring the speculative demand for money the cash balance approach does
not assign a role to the rate of interest as a determinant of the rate of interest.
Therefore the theory is excluded from a whole body of monetary theory dealing
with the rate of interest.

4 .Overemphasis on real income as a determinant of K. Factors like monetary

habits, business integration,price level etc equally influence the size of K.

5. Apart from changes in the total demand for money, changes in the distribution
of general demand between different categories of cash balance holders is also
important.The pattern of distribution substantially affects employment,income
and output .

6. The cash balance approach is based on the assumption that the demand for
money has unitary elasticity and elasticity of demand for money is unity only
under static conditions
In Pigou equation P = KR /M [ c + h (1-c)] if we assume that K,R c and h are constant
then the equation gives a rectangular hyperbola indicating unitary elasticity of demand
for money so that a halving of the purchasing power of money leads to a doubling of the
demand for money and vice-versa.The product of the value of money and quantity of
money demanded is a constant
7. The cash balance approach is subject to some of the criticisms of the
transactions approach. For eg by assuming K and T to be constant is as extreme
as assuming velocity V to be constant.
8. Though the Cambridge economists did recognise the fact that changes in the
money supply in the short run would partly change output, employment and partly
price level they failed to explain by how much output and prices would change for
a given change in the money supply, They failed to separate the output and the
price effects of changes in the money supply.
9. The CB approach fails to explain the real forces behind the changes in the price
level. It ignores important variables like savings and investment which are the
main causes for changes in the demand for money.
10. By giving importance to purchasing power of money, it has ignored the level of
economic activity as a important determinant of the demand for money