Page 115 - DECO402_Macro Economics

Macroeconomic Theory

Notes 1 1 100
If people reduce cash balance (k) from to then price level will increase to 1 = Rs. 2
per unit 5 10 500×
10
Pigou’s Equation: Pigou’s equation is as follows:
kR
P =
M
(Here, M: total quantity of money, R: gross actual income, k: That part of actual income which people
want to keep as cash)
Value of money is inverse of the general price level. People do not keep all their money in form of
currency or legal tender money. They keep a part of their cash balance deposited in bank. Keeping
this fact in mind, Pigou made some amendments in his equation in which some part of k is kept in
form of legal tender money and some part in bank. New equation is as follows:
kR
+
( −
P =   C h1 ) c  
M
or
kR
M =   C h1 ) c  
( −
+
P
(Here, c = cash with the people, 1 – c: bank deposits, h: cash reserve ratio or that part of bank deposits
which bank keeps with itself as cash)

Illustration

1 1 1
Assume, K = ;c = ;h =
4 2 10
R= 2000 Quintal of rice, M= `. 550
We have to find P
We know that

kR
+
( −
P =   C h1 ) c  
M
1 × 2000
= 4  1 + 1    1 − 1    
550 2 10   2  
500 1 1 1 

=  + × 
550 2 10 2 

500 1 1 

=  + 
550 2 20 

10 11 1
= × = quintal of rice.
11 20 2
If we have to find M according to the Pigou’ equation, we may find it out through the below mentioned
method:

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