Page 114 - DECO402_Macro Economics

Unit-12: Demand of Money: Quantity Theory of Money

Supply of Money = Notes + Coins+ Demand Deposits Notes
If it is thought about at a specific point of time, it is believed that velocity will have no effect on supply
of money.

An Important Observation
Supporters of Cambridge equation have recognised not only money’s job as a medium of exchange
but also as a store of value. But while describing the concept of demand of money, they have
emphasised on using demand for money in form of medium of exchange and for dealing an
emergency situation. In other words, their meaning with ‘demand for money’ is ‘demand for
exchange’ and ‘demand for precaution’. Importance of demand for money with an objective of
speculation or importance of demand for money with an objective of earning money from money
was ignored by them.
2. Demand for Money: According to Cambridge equation by demand, is meant, the people’s
desire to keep money as cash balance. As per Fisher, demand for money is done only for
using it as a medium of exchange. But as per cash balance equation money is demanded
not only for using it as a medium of exchange but also with an objective of accumulating
money. Cash balance is that ratio of annual actual income, which people like to keep as cash
money. Hence,
Demand for money= Sum of Cash balances

As per this equation, if supply of money remains constant, on an increase in demand for money or
cash balance prices will decrease because people will like to keep with them, a big part of their
income as cash and their demand for goods and services will reduce. As opposed to this, if demand
for cash balance will reduce, demand for goods and services will increase because of will price level
will rise. Accordingly, demand for money or cash balance has an inverse relation with price level.

Different Variants of Cash Balance Equation

There are various forms of cash balance equation. Important ones are described as follows:
Marshall’s Equation: Dr. Marshall has explained the value of money though the below mentioned
equation:

M = kY
(Here: M : quantity of money, Y: monetary income, K: that part of the income which people want to
keep as cash)
Because monetary income (Y) is the product of gross production (O) and price level (P), i.e., Y = PXO.
Hence, the above equation may be written as follows:
M
M = POk or P = Ok

1 1
If M = ` 100 crores, O = 500 units, k = (i.e. people want to keep th part of their income as cash)
then, 5 5

M 100 100
P = = = = 1 ` per unit
Ok 1 100
500×
5

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