Different Variants of Cash Balance Equation

(Note-Compiled from internet for teaching purpose )

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 through the

M = kY
below mentioned equation:
(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 = POk or P =M/Ok

Pigou’s Equation: Pigou’s equation is as follows:

P = kR
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.
 In Fig. 12.2, demand and supply of money is shown on axis OX and
value of money is shown on axis OY. DD is the demand curve of
money. Q1M1; Q2M2;
Q3M3 are supply curves of money. At a specified point oftime, supply of money is
constant; hence it is represented through a straight line. When supply of money increases
from OM1 to OM2, then, value
of money decreases from OP1 to
OP2. Reduction in value of
money is in proportion to
increase in supply of money. In
the same way, when
supply of money increases from
OM2 to OM3, value of money
decreases from OP2 to OP3.
Still in reference to change in
value of money, Pigou has given
more importance to K as
compared to M. i.e., in
comparison to supply of money,
demand for money is considered
to be a more important
determinant of value of money.

D.H. Robertson gave an equation similar to that of Pigou but with a slight difference. He
stated:

P = M/KT

(Here, P: Price level, M: Quantity of Money; T: quantity of goods and services bought at a
specified point of time; k: that part of T which people want to keep as cash)

Robertson’s equation is considered to be better than Pigou’s equation because it is easy.

The similarities between the Fisherian and the Cambridge approaches are discussed
below:

1. Similar Equations:

Robertson’s cash-balance equation, P = M/KT is quite similar to that given by Fisher; P =

MV/T. Both the equations use the same symbols with same meanings. The only difference
lies in V and K which are, in fact, reciprocal to each other; V refers to rate of spending and K
refers to the extent of holding or not spending.
It means when people want to hold more money (higher the K), they want to spend less or the
velocity of circulation of money will be less (lower the V). Thus, by substituting 1/V for K
and 1/K for V, the two equations can be reconciled.

2. Same Conclusions:

Both the approaches lead to the same conclusions, i.e., the price level or the value of money
depends upon the money supply. In other words, there is direct proportionate relationship
between the money supply and the price level and inverse proportionate relationship between
money supply and the value of money. If the money supply is doubled, the price level is also
doubled and the value of money is halved.

3. Same Phenomenon of Money:

MV of Fisher’s equation, M of Robertson’s and Pigou’s equation, all refer to the same thing,
i.e., the total supply of money.

4. V and K-Two Sides of the Same Phenomenon:

Fisherian and Cambridge approaches are not fundamentally different from each other because
they represent two sides of the same phenomenon. The Fisherian approach emphasises
money as a stock, while the Cambridge approach stresses money as flow.

Dissimilarities between the Two Approaches:

In spite of similar conclusions and implications of the two approaches, they have some
notable differences.

Important dissimilarities between the two approaches are discussed below:

1. Relative Stress of Supply and Demand for Money:

Fisher’s approach stresses the supply of money, whereas, the Cambridge approach lays more
emphasis on the demand for money to hold cash.

2. Definition of Money:

The two approaches use different definitions of money. The Fisherian approach emphasises
the medium of exchange function of money, whereas the Cambridge approach stresses the
store of value function of money.

3. Flow and Stock Concepts:

The Fisherian approach regards money as a flow concept; money is considered in terms of
flow of money expenditures. The Cambridge version regards money as a stock concept;
money supply refers to a given stock at a particular point of time.

4. Transaction and Income Velocities:

Fisherian approach emphasises the importance of the transaction velocity of circulation (i.e.,
V). The Cambridge Version, on the contrary, lays stress on the income velocity of the part of
income which is held in the cash balance (i.e., K).

5. Nature of P:

In both approaches, the price level (P) is not used identically. In Fisher’s version, P is the
average price level of all goods. On the contrary, in Cambridge version. P refers to the price
of consumer goods.

6. Factors Affecting V and K:

Fisher is concerned about the institutional and technological factors governing how fast
individuals can spend their money (i.e., V). The Cambridge School, on the other hand, is
concerned about the economic factors determining what portion of their wealth the public
desires to hold in the form of money (i.e., K).

7. Relationship between M and P:

The Fisherian approach maintains that any change in the money supply produces proportional
changes in the price level. This is because Fisher believes that both velocity and real income
are in the long run independent of each other and of supply of money.

In the Cambridge approach, the price level may change by more or less than the money
supply; it depends upon what happens to the stock of non-monetary assets and their expected
yields on which the Cambridge economists believed the desired cash balances depend.

8. Different Approaches to Monetary Theory:

Both Fisher and Cambridge School led to the development of two different approaches to the
monetary theory. Fisher’s approach has given rise to an inventory theory of money holding
largely for transactions purposes. On the other hand, the Cambridge approach has been
developed into portfolio, or capital theoretic approach to monetary demand.

The Cambridge version is superior to the Fisherian version on the following grounds:

1. Realistic Theory:

The Fisherian approach is mechanical in the sense that it maintains a mechanical, i.e., direct
and proportional relationship between the supply of money and the price level. The
Cambridge approach, on the contrary, provides a realistic analysis. By emphasising K, it
introduced the role of human motives in the determination of the price level.

2. Broader Theory:
The Cambridge approach is broader and comprehensive because it takes into account income
level as well as changes in it as important determinant of the price level. The Fisherian
approach ignored income level and makes the price level dependent upon the quantity of
money and the total number of transactions.

3. More Useful:

According to Kurihara, the Cambridge equation, P = M/KT, is analytically more useful than
the Fisherian equation, P = MV/T, in explaining money value. It is easier to know the amount
of cash balances of an individual than to know his expenditure on various types of
transactions.

4. Causal Process:

According to Fisher, changes in the price level are caused by the changes in the quantity of
money. But according to the Cambridge economists, the price level may change even without
a change in the quantity of money, if K changes. Given the quantity of money, a desire to
keep less money balances will raise the price level and vice versa.

5. Explanation of Cyclical Fluctuations:

The variable K in the Cambridge equation is more significant in explaining the trade cycles
than the variable V in Fisher’s equation. During inflation, people decrease their cash balances
(K) and as a result, the value of money falls and the price level rises. On the contrary, during
depression, the desire to hold money (K) rises and, as a consequence, the value of money
rises and the price level falls.