BCom 3rd Year Quantity Theory Financial Money Study Material Notes in Hindi

BCom 3rd Year Quantity Theory Financial Money Study Material Notes in Hindi:  Quantity Theory of Money Different Meaning of Value of Money Determination of Value of Money  Theories of The Determination of Value of Money Equation of the Quantity Theory of money Similarities Between Fisher and Cambridge Equation :

BCom 3rd Year Nature Importance Financial Money Study Material notes in hindi

QUANTITY THEORY OF MONEY

QUANTITY THEORY OF MONEY

We know that there is an inverse relationship between the price of money and price of commodities. It means when price of money decreases, the price of commodities increases and when the price of money increases, the prices of commodities decreases. So, it gets clarifies that the price of money changes constantly. Why is there a change in the price of money? The study of the “Quantity Theory of Money’ is important to give the answer of this question. In other words, the ‘Quantity Theory of Money’ defines the causes of changes in the value of money.

Quantity Theory Financial Money

DIFFERENT MEANING OF VALUE OF MONEY

It is true that the price of money refers to its purchasing power. Even then there are following three differences related to the value of money :

(1) Purchasing Power: Purchasing power refers to the ability of purchasing goods and services with a unit of money. This purchasing power is often measured in comparative terms. It means what amount of goods and services could be purchased with a unit of money in a base year and what amount of these goods and services can be purchased with that very unit in the current year. Index is also prepared on this bases only.

(2) Rate of Interest : A meaning of the value of money is also often associated with the rate of interest. In this sense, it is predicted how much interest can be obtained from a certain amount of money in a year.

(3) Foreign Exchange Rate : In this sense of money, it is predicted how many units of foreign money can be purchased with a certain unit of money of a particular country.

In all the above three senses, the value of the money can be predicted. But the most common and accurate sense is that which is associated to the purchasing power of money.

Quantity Theory Financial Money

DETERMINATION OF VALUE OF MONEY

To understand the ‘Quantity Theory of Money’ it is essential to know on which factors the value determination of money depends. According to economists, money is also a material. Now if we consider money as a material then its value should be determined just in the way the value of any material is determined We know that according to common rule of economics, price of any materials determined by the forces of demand and supply. So the value of money is also

Determined at that point on which a balance is established between the demand and supply of money. To understand the value determination of money, it is essential to understand the meaning of demand and supply of money.

Demand of Money : Money is also demanded like commodities by the people of any country. But there are some differences between demand of any commodity and demand of money. Commodities carry the quality of utility. So people demand commodities to satisfy their utility. But money doesn’t satisfy any utility. Goods are purchased for fulfillment of various requirements with the help of money. In other words people get direct satisfaction through the demand of commodities while they get indirect satisfaction through money. Demand of money in any country is based on the supply of goods in that country. There is no uniform supply of goods all the time and so there is also not uniform demand of money all the time. Thus the demand of money in any country depends on the amount of goods and services available there.

Supply of Money : By supply of money, we refer to that amount of money which is available for exchange in the economy. As a source of exchange both legal tender money and non-legal tender money are together in the economy. Metallic money and paper money are included in legal tender money while credit instruments fall under the category of non-legal tender money. So all the three metallic money, paper money and credit instruments used in a country are included in the supply of money. But the form of money which people keep permanently locked in their safe or keep buried under the ground can’t be included in the supply of money because such money is not used for the purpose of exchange.

Supply of money depends on many factors. For example—the system of issuing note by the government of the country, the monetary policy of the government, amount of metals like gold and silver in the country and the confidence of people in credit money. Besides these, the supply of money is also affected by the velocity of circulation of money.

Quantity Theory Financial Money

Velocity of Circulation of Money:It refers to the number of circulation practices of a certain unit of money at a certain time. Suppose a person pays 100 wages to a labourer. The labourer purchases food materials with that money on the same day. Again that trader purchases a new commodity with that 100 on that very day. It means 100 had the velocity of circulation 3 in 1 day. The velocity of circulation of money depends on the tendency of people. If people have more tendency of saving, there will be less velocity of circulation of money. On the other hand, if people will have a higher tendency of Expenses, the velocity of circulation will be more.

Quantity Theory Financial Money

THEORIES OF THE DETERMINATION OF VALUE OF MONEY

Different scholars have described various theories of determination of value of money. Every theory has its own characteristics. The description of some important theories are given below :

Commodity Theory of Money : It is the oldest theory of determination of value of money. According to this theory the value of money is also determined by demand and supply as it happens in the case of other commodities. This theory came in the use at the time when there was the use of metal currency in almost all countries of the world and it was made of gold or silver. This theory was considered proper those days because the market price of gold and silver and the face price of money were approximately the same. These days the paper

Money has come in use in all the countries of the world. Paper money is made of paper and its internal value is zero. So there is no rationality of this theory at present.

If we consider that like other commodities value of money is determined by demand and supply, it becomes essential to clarify that by the demand and supply of money, we refer to the demand and suply of that material of which money is made. It simply means that the value of money will be governed by the market value of that metal of which the money is made. It is possible only when there is some internal value of money material. In the use of paper money there is no internal value of money material. Metallic money is also like symbolic money in those countries which have both paper money and metallic money in use.

Some economists hold that paper money is issued with the support of gold. It can be argued here that every country have their own system of issuing paper money. So it can be claimed perfectly that there is cent per cent security of gold behind paper money. Later amendments were made in this theory. Even after these, today ‘Commodity Theory of Money’ is impractical.

State Theory of Money : Prof. Fredrick Knapp is the father of this theory of value of money. According to him, “The soul of currency is not in the material of the pieces, but in the legal ordinances which regulate their use.” It become clear from this definition that the value of money does not depend on this factor that which money material has been used in making money, but it is determined by the government. The internal statement of this theory in the present day is that money is issued and regulated by the government of India or central bank. So, its value is also determined by the government. According to Prof. Knapp, the government determines the value of money in the following ways:

(1) Legal Recognition : The material which is given a legal acceptance by the government, it wins the confidence of people. People start accepting it as money. If this legal acceptance is removed, it won’t be in use as money. Due to this legal acceptance, money becomes a medium of exchange and the base of deferred payment.

(2) Issue of Money : The amount of money issued by the government also determines the value of money. If the government wants to increase the value of money, it can do so by reducing the amount of money. Similarly, if the government wants to reduce the value of money, it can do so by issuing additional money.

Quantity Theory Financial Money

(3) Determination of Commodity Prices: Government in some countries determines the prices of commodities under some special circumstances. In India also, the government determined the prices of essential goods during the emergency. At present also, the prices of commodities for the ration shops (PDS Shop) are determined by the government. The government determines the value of money indirectly through this policy.

Drawbacks of Theory: Following are the drawbacks on the basis of which this policy is criticised :

(1) The critics have the opinion that just by giving legal acceptance to anything; the government can’t give it the form of money. For this, it is essential that people should accept that substance as money. The incident of Germany is an example of this. After the World War I, the German government gave ‘Mark legal acceptance as currency, but people did not accept it. As a result, Mark could not continue its use as money.

(2) The critics also opine that it is true that the government supplies money. But it does not mean that the government only should determine the value of money. The real value of money is determined by its demand and supply.

(3) About the price determination of goods by the government, the critics hold that the government does it for selected commodities only. Thus, it can’t be the basis of price determination.

Despite the above criticism, the importance of this theory can’t be rejected. The legality of money material can be an important element in determination of the value of money.

Quantity Theory of Money : This is an old theory related to the value determination of money. The conclusion of this theory is that the value of money is determined by changes taking place in the quantity of money.

There is lacking of solid proof regarding the founder of this popular theory related to determination of value of money. Different economists discuss the names used as the possible founders. The names used as possible founders areDauan Zatti, Jean Bodlin etc. Later it was amended by John Locke, David Hume, Adam Smith, Ricardo, J.S. Mill etc. But the credit of making this theory popular goes to the famous American economist Irving Fisher. So, this theory is popular by the name “Fisher’s Quantity Theory of Money.”

Quantity Theory Financial Money

Before knowing Fisher’s point of view on this theory the study of the determinations of various scholars on this theory is essential. Some important definitions are as follows:

(1) According to J.S. Mill, “The value of money, other things being the same, varies inversely as its quantity; every increase of quantity lowers the value and every diminution raising it in a ratio exactly equivalent.”

(2) According to Prof. Thomas, “According to the quantity theory of money, the value of money is determined by the relationship between the demand for money and its supply. It asserts that given the conditions of demand for money a given increase or decrease in its supply will lead to a proportionate increase or decrease in the general level of prices and as the value of money varies inversely with the price level, an increase in the volume of money will lead to a fall in its value and decrease to rise in that value.”

(3) According to Wicksell, “The value or purchasing power of money varies in inverse proportion to its quantity, so that an increase or decrease in the quantity of money, other thing being equal will cause a proportionate decrease or increase in its purchasing power in terms of other goods and thus a corresponding increase or decrease in all commodity prices.”

After the study of the above definitions it becomes clear that the scholars have laid much emphasis on the quantity of money in determining the value of money. That is why it is called the quantity theory of money.

Assumptions of Theory : The Quantity Theory of Money is based on certain assumptions. In the above definitions of the theory the economists have used the term other factors remain constant.’ Its simple meaning is this theory works only when there is no change in any other thing. The main assumptions of this theory are as follows:

(1) There should be no Change in the Demand of Money : It is essential for the functioning of this theory that the demand of money should stay still. It means there should be no change in the demand of money due to trade, industries,

employment etc. So, when the demand will be stable, the value of money will be determined by its supply only.

(2) There should be no Change in the Transactions Completed through barter System : Although the barter system has largely come to an end, it is used for some transactions in a few countries. The quantity theory of money holds the opinion that the barter system is not in use. So, this theory can work only when there is no change in the amount of barter system as there is no role of money in the transactions of these goods.

(3) There should be no Change in the amount of Credit Money:Even when there is no legal recognition for the credit money, it is very popular. It is the assumption of this theory that there should be no change in the amount of the use of credit money.

Quantity Theory Financial Money

(4) The Ratio between the Credit Money and Money in Circulation should be Stable : The quantity theory of money is based on the assumption that there should be no change in the ratio between the credit money and money in circulation in the country. We know that the commercial banks keep a certain part of their customer’s deposits with them and distribute the remaining in the form of credit. So, there is formation of credit on the bases of this deposit. so this theory won’t work in this ratio.

(5) There should be no Change in the Velocity of Circulation of Money : By the velocity of circulation of money we refer to the frequency of purchasing goods and services with a definite unit of money within a limited period. The quantity theory of money works by considering that the velocity of circulation of money will be stable. So, this theory will work only when there is no change in the velocity of circulation of money.

Quantity Theory Financial Money

EQUATION OF THE QUANTITY THEORY OF MONEY

The economists had presented the quantity theory of money in the form of an equation in the olden days. It established relationship among the amount of money, the transactions made through it and the price level. The equation presented by the ancient economists was as follows:

Where,  P = the price level of goods and services

M = the amount of money in circulation in the country

T = quantity of trade

T (The quantity of Trade) is considered stable in this equation and it is assumed that all changes in the price levels of goods and services take place due to the change in M (The amount of money) in the country. Thus there is a direct relationship between Pand M. As a result Pincreases naturally with the increase of M.

After sometime the economists found that the velocity of circulation of money has not been included in it. Thus by removing this fault, the equation was amended to be in the following form:

In this equation V refers to the velocity of circulation of money. According his ecuation P (The price level) is determined by the transactions done through Mhuse there is a direct and proportional relationship between P and MV. But the major fault with this equation is that the credit money has not been included in it. So, Prof. Irving Fisher presented a new equation to remove this fault.

Fisher’s Equation: Prof. Fisher has presented his equation as the quantity theory of money in the following ways:

If we explain fisher’s equations,

PT = MV + M’V’, we will find that PT is the demand of money and it tells about the supply of money in the form of MV + M’V’. It is clear from Fisher’s equation that there is a direct relationship of price level with MV + M’V’. Thus, according this equation if an increase in the supply of money is done and other factors stay constant, there will be a fall in the price level. Here ‘Other Factors stays constant refers to no change in the amount of trade. Thus, this theory tells about the mutual relationship between the amount of money and the prices of goods and services. So, it is called the ‘Quantity Theory of Money

Assumptions of Fisher’s Theory : In the presentation of the above equation Fisher has assumed that V (The velocity of circulation of money), V (The velocity of circulation of credit money) and T (Trade, transactions) stay stable and there is a direct relationship of M(legal tender money) and M'(Credit money) with P. In other words, if there is an increase in M there is also an increase in P (General Price level). On the contrary, if there is a decrease in M, there is also a decrease in P. But Fishers has also considered that all these factors stay stable for a short period only. He stated the reason for if that the quantity of trade P , and the use of money stay stable for a limited period only because there is no change in population, production, demand and the amount of consumption in a short period. Besides these, there is also no 0 M, MM, change in the habits and interest of people,Quantity of Money (M) in a short period. Thus, on this basis in a short period if the demand of money is stable then there is a direct impact of an increase or decrease in  on .

Quantity Theory Financial Money

Clarification through Diagram : In the given picture line OX represents the amount of money (M) and line OY shows the price level. It is clear from the picture that when the quantity of money in circulation in the economy is OM, the price level is equal to OP, But when the amount of money is made OM,, the price level increases to be OP, On the contrary, when the amount of money reduces to be OM, the price level reduces to be OP.. In this presentation OT curve passes through points C, A and B which tells about the mutual relationship between changes in the amount of money and price level.

Quantity Theory Financial Money

CRITICISM OF THE QUANTITY THEORY OF MONEY

Following are the criticism of the amended form of the Quantity Theory of Money’ presented by Prof. Fisher :

(1) Unrealistic Assumptions : The critics have the opinion that the assumptions taken as the basis in the analysis of the ‘Quantiy. Theory of Money! are unrealistic. The critics have presented following arguments in support of this statement

(a) Assumption of Full Employment is Unrealistic : The critics have said that this theory of Prof. Fisher is based on this assumption that there is the condition of full employment in the economy. But if seen in reality, there is no condition of full employment in the economy.

(b) V and T do not remain Constant in the Short Run : Prof. Fisher has supposed that there is no change in V and Tin the short run. But it is not so in reality. There are the phases of recession and boom in the sector of trade. Rise in V in the time of boom and reduction in V at the time depression take place in the short run only. It also has its effects on M because the effect of change in the amount of money is on the production of goods also. The economic history of many countries accepts this facts that there has been increase in the volume of trade due to increase in the supply of money. So, it is illusionary to imagine that T will stay stable always in the short term.

(c) M and V are not Independent Variables : Fisher has assumed in his theory that M and V are independent units. It means they do not have effect on one another. But it is not true in reality. An increase in M increase in P (Price level) which in turn leads to an increase in V because in this situation there is a greater possibility of future price rise. Thus, it can’t be supposed that there will not be a chance in V even if there is an increase in M. Thus M and V are not independent.

(d) Relation between Man M’: Prof. Fisher has the opinion that there is a proportional relationship between legal tender money (M) and credit money (M’). But the critics don’t hold it true. According to them when there is a boom in the economy, the amount of credit money increases. So, the assumption made by Fisher is wrong.

(2) Too much Emphasis on Supply of Money : The critics say that it is the general rule of economics that the price of any commodity is determined by its demand and supply. In the same way, value of money is also determined by its demand and supply. But in the ‘Quantity Theory of Money’ the supply side has been emphasised in the value determination of money and demand aspect has been neglected. Due to this fault of the ‘Quantity Theory of Money’ Prof. Keynes has propounded another theory of value determination of money.

(3) The Concept of Price Level is not Clear: Prof. Fisher has considered in his theory that only the amount of money has influence on the prices of goods and commodities. But it is not true in then opinion of critics. They say that there are so many non-monetary factors like an exceptional change in demand on a particular time, the financial policy of the government, political unrest, and changes in the amount and cost of production which influence the price level. De Cock has said criticising this theory, “The amount of money has been unnecessarily stressed in the ‘Quantity Theory of Money’ while there is no close and direct relationship between the amount of money and price level of commodities.”

(4) Negligence of Trade Cycle : The supply of money has been taken as the basis for the determination of value of money in the ‘Quantity Theory of Money’. But the supply of money generally becomes ineffective in the condition of trade cycles. The price level decreases without a decrease in the amount of money during recession and price level rise without an increase in the amount of money during boom in the economy. In this way this theory does not clarify those changes in price level which arise due to trade cycles,

(5) This Theory Shows Long Run Tendency Only : It is a major fault of this theory that it analyses the long-term aspect of value of money but do not hae short-term analysis. However there are some important changes in the value of money in short period. Thus, negligence the short-term aspect is improper. Prof. Keynes has said, “There is not much gain by the study of longterm aspect because everybody dies in the long-term.”

(6) Static Theory : The critics say that this theory is a permanent one. There is a lack of mobility in it. This theory is based on the imagination that there is a condition of full employment in the society. But it is not so in practice. There is a condition of mobility in the economy due to the fluctuation in practice. Thus, this theory is unable to measure the value of money in a mobile economy.

(7) Non Acceptance of the Importance of Time Lag: Fisher’s Quantity Theory emphasis the fact that with the change in the supply of money there is also a change in the prices of commodities. But the critics say that the change in the supply of money does not have an instant impact on the price level in the country, but the impact is slow and gradual. However, in the area of monopoly it has instant effect, but in complete and incomplete competition it has gradual effect.

(8) Negligence of Velocity of Circulation of Money : It is a fault of this theory according to the critics that it does not analyse the velocity of circulation of money, nor does it throws light on the elements influencing it. Prof. Marshall has said, “A theory determining the value of money should throw light on all the causes influencing the velocity of circulation of money.”

(9) Money is not only a Medium of Exchange but also the Means for Store of Money : As we know, money is not only a medium of exchange but also a means for store. But in this theory its effects are connected only to price level and thus money is presented as the mode of transaction. Thus, this theory is not perfect with the view.

(10) Value of Money is the Result of Total Income : According to Prof. Crowther, “Value of money is determined by the total income of the country, not by the quantity of money.” They opine that the cause of fluctuation in the total income should be found out.

(11) International Effects : These days, the market of commodities has become international. Every country wants to sell its products in other countries. As a result there is a competition in the prices of commodities. If we consider the point of Fisher’s Theory that the price level of commodities depends on the amount of money, there would be so much difference in prices of goods that it would not be able to make its place in the international market. Thus, Fisher’s! logic is not correct.

Conclusion : On the bases of above criticism it can be said that, the “Quantity Theory of Money’ is unrealistic, faulty and meaningless. According to Prof. Keynes, “This theory is not only faulty but also incomplete and imaginary.” In reality, the mathematical form of this theory is insufficient. But, in spite of these criticisms it is not to say this theory unimportant. It is true that it is not complete with mathematical point of view, but it gives the information of a tendency. It must be accepted that the changes in the prices in a country is certainly influenced by the changes in the amount of money. Robertson has said, “The Quantity Theory of Money is a strange truth to understand the value of money which is essential to understand to know the relationship between the amount of money in the real life and the prices of commodities.”

Quantity Theory Financial Money

Prof. Fisher has presented many examples to prove the truth of his theory. Some of these are given below :

(1) When the Spanish discoverers found out new mines of silver, they started exporting more and more silver to European countries, as a result the price – level went up in these countries.

(2) There was overproduction of goods in the period between 1820 and 1844

but the amount of money could not be increased in that ratio because there was not sufficient gold with Britain; as a result, the price level fell very much in Britain.

(3) There was a large scale export of gold from Australia and California to the countries having gold standard. As a result there was price rise in these countries. Again when the import of gold in these countries reduced, the price began to fall.

(4) There was inflation in Germany during World War I due to large scale issue of paper money.

(5) During the worldwide depression in 1929 that was a great fall of price in almost all countries due to deflation.

The above examples clarifies that the ‘Quality Theory of Money’ is not unimportant.

Cambridge Quantity Theory of Money : The Cambridge economists, being dissatisfied with Fisher’s analysis, explained this theory in a new way. The main economists supporting this group are Marshal, Pigou, Cannen, Hartle, Robertson etc.

If Fisher’s ideology is very popular in America, there is more recognition for Cambridge ideology in European countries.

The main features of Cambridge’s Quantity Theory are as follows:

(1) A Part of Income is kept in the Liquid Form : Prof. Fisher has considered money only as a medium of exchange while analysing the ‘Quantity Theory of Money.’ In other words, money is demanded to purchase goods and services. But the Cambridge economists do not agree with this view point. They have the opinion that nobody knows what is hidden in future. So everybody wants to keep a part of his present income in the form of cash or liquid so that if there is a sudden need it can be fulfilled. This is the thought not only of individuals but also commercial institutions and government. Thus, the value of money is determined by the demand of cash remainders kept by the people. So Cambridge Equations are also called cash balance equation. Thus, according to Cambridge Economists, “The amount of money which is kept by the individual, commercial institutions and government to meet their day to day needs is called demand of money.”

Thus, the value of one rupee of money will be 1/4 unit which means its value per unit will be 4.

(2) The demand of Money depends on the Liquidity Preferences: An individual wants to save a part of the amount obtained as his income. He can consume this saved money in many ways. He can invest money in fixed assets by purchasing land, building etc. or he can purchase shares or debentures of any company. They can also keep this sum deposited with banks. But all these investments are not called liquid. Fixed assets can’t be sold instantly to obtain cash. So it can’t be called liquid money. Shares and debentures can be converted into cash instantly. So these are called liquid money. Similarly, money deposited with banks is called extremely liquid. Thus, more will be liquid preference in people; the more will be demand of money.

(3) Demand of Money is Influenced by Many Factors : Demand of money is influenced by many other factors, a few of which are as follows:

(i) The Period of Obtaining Income: For different persons, the income getting periods are different viz, daily, weekly, monthly, irregular etc. The more will be the period of income getting for a person, the more will be demand of money for him. On the contrary, the less will be the period of income getting, the less will be demand of money as the person will not keep much money with him for the fulfillment of his requirements.

Quantity Theory Financial Money

(ii) Distribution of National Income : Every individual keep some

money with him in a country where there is more equity in the distribution of national income. Thus, there is a higher demand of money in such countries. On the other hand, money is kept only by higher class people in countries with uneven distribution of national income. Thus, there is low demand of money in those countries.

(iii) The Velocity of Circulation of Money : The nature of liquidity Preference among people is also important for the demand of money. If people give preference to liquidity, it simply means they will use money lesser for exchange due to which the demand of money will increase. On the other hand, if people don’t give preference to liquidity, the velocity of circulation of money will increase due to which more exchanges will be with less money and there will be less demand of money.

(iv) Population : The more will be population of a country, the more will be demand of money. On the other hand, the less will be population, the less will be demand of money.

(v) Trade Cycle : There comes the period of both recession and boom in the trade world. During recession, as the profit in trade and industries receded the traders start keeping cash with them and wait for positive opportunities instead of investing their money in trade. Similarly, the consumers also purchase fewer amounts of commodities with the prospect of more fall in price in future. Thus, every class of people keep cash with them during depression due to which the demand of money increases. On the contrary, the business class invests more and more money in trade and industries during the boom with prospect of earning! more profit. Consumers also start purchasing goods in bigger amount for fear of further rise in prices for future. Thus, people don’t keep cash with them during the boom due to which there is less demand of money.!

(vi) Banking Habits: If banking habits develop among people, more and more payments take place through cheques and drafts. In this situation, there is less demand of money.

Quantity Theory Financial Money

SIMILARITIES BETWEEN FISHER AND CAMBRIDGE EQUATION

Despite being many differences in the ideologies of Fisher and Cambridge economists, there are some similarities which are as follows:

(1) Prof. Fisher’s equation is related to a period of time while Cambridge equation associates with point of time.

(2) The conclusion of Fisher and Cambridge ideologies is the same. Both show a direct and proportional relationship between the price level and the amount of money.

(3) The amount of money has been considered an important element of price determination in both the ideologies.

(4) P represents the price level in both the equations.

DIFFERENCE BETWEEN FISHER AND CAMBRIDGE EQUATIONS

Differences between Fisher and Cambridge equations can be clear by the following table :

	Bases of Difference	Fishers Equation	Cambridge Equation
1	Flow and Stock of Money	Fisher equation gives importance to flow of Money	Cambridge Equation stresses on stock of money
2	Nature of Price Level	P represents the Average price level of all goods and Services	P represents the Price of Consumer Goods .
3	Stress on Demand and Supply	Fisher view point Stress on Supply of Money	Cambridge Viewpoint Stresses on demand of money
4	Time	It is Associated With Period of time	It is associated with point of time .
5	Demand of Money	According to Fisher , the Demand of Money is for Actual Transactions	According to Cambridge ideology demand of money is for Storage of money .

 

Quantity Theory Financial Money

SUPERIORITY OF CAMBRIDGE EQUATION

Quantity Theory of Money of Cambridge ideology is superior to transaction ideology of Fisher in the ‘Quality Theory of Money for the following reasons :

(1) Liquidity Preference: Cambridge equation lays emphasis on Liquidity! Preference Theory, the basic tendency of human beings in place of supply of money. On this bases ‘Liquidity Preference Theory of Keynes’ developed.

(2) Completeness: Cambridge equation of ‘Quantity Theory of Money can be called a complete theory because in it Liquidity Preference Theory, the basic tendency of value of money is determined through demand and supply.

(3) Simplicity : In this equation transactions related to only consumer goods are considered while in fisher’s equation all kinds of transactions are included. It is very easy to determine price level in Cambridge equation. So, it can be said an easy equation.

(4) Trade Cycle : Cambridge equation protects people from trade cycle. People develop the tendency of depositing money in this equation.

(5) Related to Short-Term : The equation propounded by Prof. Fisher analyses only long-term changes while Cambridge analysis presents the solution of short-term changes also.

(6) Broader Concept : According to Hicks the real cause of demand of goods have been highlighted in the Cambridge analysis and their affects have also been clarified. With this view, the concept of demand of money is broad in Cambridge equation. Fisher’s viewpoint is inactive in this sense.

(7) Applicable under all circumstances: Fisher’s equation is favourable for that economy only which has the condition of full employment, but Cambridge equation is applicable in all circumstances. Thus, it is certainly superior.

Quantity Theory Financial Money

CRITICISM OF CAMBRIDGE EQUATION

It is true that Cambridge equation is superior to Fisher’s equation, but even then it is not flowless. The critics have criticised it on the following bases.

(1) Prof. Pigou took wheat as an example in his equation. Thus, this equation shows the demand of money for consumer goods, while in practical life, there is demand of money for many reasons.

(2) Current deposits with banks have been included in the demand of money in this equation. It has been supposed that a current deposit with banks is a part of income. But if a trader takes loan from the bank and then deposit it as current deposit, it is not a part of income.

(3) With current deposits, there are also fixed deposits with bank. But fixed deposit has not been given any place in this equation.

(4) Cambridge equation does not clarify the fact how price level will be changed due to changes in income and saving.

(5) It is also a fault of this theory that it fails to analyse the complex problems of the economy. The increase in production and income can’t be concluded on the bases of this equation.

(6) It has been supposed in this equation that the amount of cash reserve is influenced by K but in reality the amount of money is influenced both by Rand K.

(7) Cambridge equation does not pay attention to speculation demand of money while there is demand of money for this also.

Considering the above criticism, Prof. Keynes has presented the amended form of the Cambridge equation as follows:

n = pk +rk”)

where, n = quantity of money

p = general price level

k = units of consumption

r= the ratio of cash kept by banks against their deposits.

K= the amount of units of consumption for which the purchasing power is kept in the form of credit money

Quantity Theory Financial Money

EXERCISE QUESTIONS

Long Answer Type Questions

1. Explain the Quantity Theory of Money.

2. Explain critically the Quantity Theory of Money.

3. Explain critically Fisher’s Quantity Theory of Money.

4. Examine Cambridge Approach of Quantity Theory of Money.

5. What do you mean by Value of Money? Explain the Quantity Theory of Money.

6. Describe the Quantity Theory of Money. Distinguish between Fisher and Cambridge

Short Answer Type Questions

1  What is Commodity Theory of Money?

2. What is State Theory of Money?

3. Proof that P= T .MV + M’V’

4. Describe the superiorities of Cambridge Equations. 5. Explain the assumptions of Fisher’s Theory.

III. Objective Type Questions

Choose the correct option

1. What has not been considered stable in the equation P = MV + M’V’                                                                                                       t

(a) P

(b) V

(c) M

(d) T

2. Value of money refers to ………

(a) The interest rate of money

(b) The superficial price level of money

(c) General Purchasing power of money

(d) All these

3. Value of money is determined by ………

(a) Demand of Money

(b) Supply of Money

(c) Demand and Supply of Money

(d) None of these

MV + M’V’

4. Who gave the equation p = MV+MV

(a) Fisher

(b) Marshall

(c) Pigou

(d) Crowther

5. What has been taken as an example by Pigou in the analysis of his equation?

(a) Rice

(b) Wheat

(c) Maize

(d) Paddy

6. Who presented the amended form of Cambridge equation?

(a) Malthus

(b) Prof. Keynes

(c) J. K. Mehta

(d) Knapp

(Ans. 1. (c), 2. (a), 3. (e), 4. (a), 5.(b), 6. (b).]