Chapter 6 complete

6.3.2 Cash-Balance Approach or Cambridge Approach 
In Fisher’s quantity equation or exchange of equation, we have seen that money is demanded 
not for its own sake but for purchasing of goods and services as money serves as a medium of 
exchange. Demand for money is equivalent to the value of transactions (PQ). Demand for 
money and supply of money in Fisher’s quantity equation are considered over a period of 
time. The Cambridge economists (like Marshall, Pigou, Cannan, Robertson, and J.M. 
Keynes) do not agree with the view of the Fisher and they establish another version of 
quantity theory of money, which is called cash balance approach or Cambridge Approach. 
The cash balance approach is based on the store value function of money and demand for and 
supply of money is considered at a point of time. According to the Cambridge, supply of 
money is a stock at a particular point of time rather than flow over a given period of time. 
The supply of money and community’s aggregate demand for cash determines the price level 
or value of money in the economy. The supply of money at a particular moment comprises all 
the cash and bank deposits subject to withdrawal by cheques. According to the Cambridge 
economists Fisher’s view on demand for money is unscientific because money is demanded 
not only to serve as a medium of exchange but also to keep money in cash balance. 
According to the Cambridge economists, demand for money refers to liquidity preference, 
which individuals and firms keep with themselves to meet day to day expenses, expected and 
unexpected future events. There is direct relationship between the liquidity preference and 
demand for money. Higher the liquidity preference, higher wil be the demand for money or 
cash balance and vice versa. The basic postulates of the cash balance approach are that 
demand for money or demand for cash balance arises to meet transactions and precautionary 
motives. It must be noted here that in cash balance approach demand for speculative motive 
is not considered. The quantity theory is often illustrated using the Cash balance version of 
the quantity equation or exchange of equation. The Cambridge equation is derived from 
equation MV = PY. If we divide (MV = PY) both side by V, we get
M = (1/V) PY, Or 
6.8 

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Since V is constant we can replace (1/V) with some constant, k
M = kPY 
6.9 
Where, k = 1/V. Although it is simply an algebraic reformulation of the basic equation of 
exchange, the cash balance approach has the advantage of focussing on k, the percentage of 
nominal income held in the form of money, rather than its inverse, the velocity. 
Whatever version of the equation of exchange is used, the long-run proportionality of 
money and prices is the defining feature of the quantity theory. Differences among quantity 
theorists arise over what happens in the short run (Indeed, Keynes himself can be thought of 
as a quantity theorist I that he believed that money and prices would change in proportion in 
the long-run. He criticised the quantity theory on the grounds that the economy was rarely if 
ever in the long run; Keynes therefore, concerned himself with the short-run)
The above equation 6.9 can be termed as the Marshall’ equation 
M = kPY
6.10 
Where, M stands for total supply of money comprises total amount of money/ currency and 
demand deposits in the banks; k represents the fraction of the real income, which people 
desire to hold in the form of money or cash; P refers to the price level; and Y (in Marshall 
equation refers) to aggregate real income. 
The value of money or purchasing power of money in terms of equation 6.10 can be 
found out by dividing the total quantity of goods which the public desired to hold of the total 
income (kY) by the total supply of the money,M. Thus we have:
P = kY/M 
6.11 
Where, P represents purchasing power of the money. Marshall believed that the value of 
money is not only influenced by changes in the supply of money but also by changes in k.
Pigou has given another version of quantity equation, which is extension of equation 6.11: 
P = kY/M {C + R (1– C)} 
6.12 
Where, p stands for purchasing power of money. kY/M remain same as in Marshall’s 
equation, 6.12. C is the proportion of money, which people keeps in the form of legal tender. 
R represents proportion of cash reserve to deposits held by the bank. (1 – C) implies that 
proportion of total money, which is held by the people in the form of bank deposits. 
In the above equation, 6.12, purchasing power of money or value of money varies directly 
with k and Y and inversely with M.
The above equation can be used to find out price level as in the transactions equation, 
then Pigou’s equation can be restated as 
P = M/KY 
6.13 

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