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    The document discusses criticisms of the Quantity Theory of Money and the Cash Balance Approach to explaining money. It outlines 10 criticisms of the Quantity Theory, including that it assumes variables are independent when they are not. It then explains the Cash Balance Approach and variants proposed by Marshall, Pigou, and Robertson. Finally, it lists 7 criticisms of the Cash Balance Approach, such as unrealistic assumptions and ignoring the effect of the interest rate.

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    Money

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    The document discusses criticisms of the Quantity Theory of Money and the Cash Balance Approach to explaining money. It outlines 10 criticisms of the Quantity Theory, including that it assumes variables are independent when they are not. It then explains the Cash Balance Approach and variants proposed by Marshall, Pigou, and Robertson. Finally, it lists 7 criticisms of the Cash Balance Approach, such as unrealistic assumptions and ignoring the effect of the interest rate.

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    The document discusses criticisms of the Quantity Theory of Money and the Cash Balance Approach to explaining money. It outlines 10 criticisms of the Quantity Theory, including that it assumes variables are independent when they are not. It then explains the Cash Balance Approach and variants proposed by Marshall, Pigou, and Robertson. Finally, it lists 7 criticisms of the Cash Balance Approach, such as unrealistic assumptions and ignoring the effect of the interest rate.

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    6 views7 pages

    Money

    Uploaded by

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    The document discusses criticisms of the Quantity Theory of Money and the Cash Balance Approach to explaining money. It outlines 10 criticisms of the Quantity Theory, including that it assumes variables are independent when they are not. It then explains the Cash Balance Approach and variants proposed by Marshall, Pigou, and Robertson. Finally, it lists 7 criticisms of the Cash Balance Approach, such as unrealistic assumptions and ignoring the effect of the interest rate.

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    of 7

    Criticism of Quantity Theory Of Money

    (1.) A Simple Truism :- Quantity theory of money is a simple truism. It


    does not tell anything that people do not know already. It tells us that
    the total amount of monetary expenditure of the buyers is equal to
    the total monetary income of sellers.

    (2) Unrealistic Assumption:- This theory is based on unrealistic


    assumption that price level is influenced only change is the V,V`, I are
    quantity of money. Other factors, assumed to be constant and donot
    influence price level. In reality, these factors never remain constant
    and change in the causes change is the price level

    (3) Variables Are Not Independent:- Fisher's assumption that M,M', V,


    v'and T are independent variables is not tune. In real life, one finds
    that these variables are not independent of each other. Any change in
    one variable will effect other variables.

    (4) Lop-Sided:- according to critics, this theory lays more emphasis on


    Supply of for money. By assuming demand for money as constant,
    Fisher has dissolved the effect of demand on price determination.

    (5.) Price Level Is Not A Passive Factor:- Price level is an active factor
    to change is price level do influence the volume of trade (T)

    (6) Applicable Only In Case of Full Employment:- Quantity theory of


    money is valid only under full employment situation. But according to
    keynes, economics may be in a situation of less than full employment

    (7) Fails To Explain Trade Cycles:- This theory fails to explain why
    during depression prices do not rise despite increase is the quantity
    of money and why during boom, price rise without an increase in
    quantity of money.

    (8) Inconsistent- Quantity theory seeks to find quantity of money by


    multiplying quantity of money with its velocity of circulation.
    Quantity of money is a stock concept while velocity of money is a flow
    concept. Thus, this theory is technically inconsistent.
    (9) Ignores The Effect of Rate of Interest :- quantity theory ignores
    the effect of rate of. interest the prices. According to t Keynes, the
    conclusion of the theory that there is a a direct relation between the
    quantity of money and price level is wrong. As a matter of fact,
    change is the quantity of money affects rate of interest and change is
    rate of interest brings about change is the price. level. Hence, relation
    between quantity of money and price level is indirect and not direct

    (10) Difficult to To Measure Velocity:- It is extremely difficut to


    measure the velocity of money in Fisher's equation. How many t times
    a unit of money Changes hands is a given time is not possible to
    calculate.

    "Cash Balance Approach"

    or "Cambridge Equation"

    Economists like Marshall, Pigou, Robertson and even J. M. Keynes


    propounded Cash Balance Equation which is also called Cambridge
    Equation.

    According to CBA, the value of money is determind by the demand for


    and supply of money. at any particular point of time, supply of money
    remains constant, hence, changes in demand for money exert a direct
    impact on the value of money (price level). The theory, thus, lays
    greater emphasis on the demand for money than its supply in the
    context of price level or value of money. It is therefore, also referred
    to as Demand Theory of Money.In order to fully grasp this equation, it
    is necessary to study demand for and the concepts relating to supply
    of money.

    (1.) Supply of Money :- According to Cash balance equation, "Supply


    of money ata particular point of time is the sum total of all the notes
    and coins. with the public and the demand deposits." Thus SM = Notes
    + Coins + Demand Deposits Considered at a point of. time, supply of
    money is believed not to be influenced by the velocity of money.
    (2) Demand For Money :- According to Cambridge equation, demand
    for money refers to people's desire for holding cash balances.
    According to Fisher, money is demanded to be used only as a medium
    of exchange. But according to cash balance equation, money is
    demanded not only for using it as a medium of exchange, but also for
    the purpose of Storing wealth. Total Cash balance is that proportion"
    of the annual real income which people. desire to hold is the form of
    money.

    D= Total Cash Balance

    Demand for money or Cash inversely related balances is believed to


    be i to price level assuming that supply of money remains constant.
    Increase is demand for money or cash balances will lead to fall in
    prices, because people will desire to hold large part of their income is
    the form of cash and accordingly, will have less demand for good and
    services. On the ather hand, if demand for cash balances decreases,
    there will be more demand for goods and services and hence price
    level will rise.

    "Variants Of Cash Balance Approach"

    Marshall's Equation :-

    Dr. Marshall explams value of money in terms of the following


    equation:- M=KY • M=Supply of money or quantity of money,

    K= Proportion of income which people desire to hold as cash balance


    and

    Y= Monetary income.

    Since, monetary income (y) is the multiplication of total production


    (0) and price level (P), i.e Y= PO M=KY or M=k(PO) = ΚΡΟ

    or p= M/ko

    Pigou's Equation :- Prof. Pigou has expressed Cash balance equation


    as followes:-
    p=kr/m

    M= Total quantity of money, R= Total real mome, K = that proportion of


    real income which people wish to hold as cash balance and

    P= Value of money.

    Value of money is the reci general price level. People do not -procal I
    of general, hold all their cash balance in currency or legal tender
    money. They keep a portion of their cash balances "bank deposits.
    Keeping thie the form of fact is view, Pigou modified his equation
    wherein. some portion of K iis kept as as legal tender and some
    portion as bank deposits. The new equation reads as :-

    C= Proportion of cash balance that the people wish to hold in the


    form of legal tender money, 1-C= Proportion of cash balance which
    people which to hold in the form of bank deposite, h= that proportion
    of bank deposits which Is held by the bank as cash, Jolog Cash reserve
    ratio.

    According to Pigou, if K,R, C and I are assumed to be constant, then


    change in the supply of money will cause a proportionate change is
    the value of money.
    Pigou accords greater significance to k rather than M. That is, demand
    for money. is believed to be a more significant determinant of the
    value of money than the supply of money.

    #Robertson's Equation:- Brof. Robertson puts forward the following


    equation :-

    M=PKT

    or p=M/KT

    P=price level, M= quantity of money, T= quantity of goods and


    services purchased during a period of time,

    K= that portion of T which people want to keep in cash.

    Robertson's equation is considered better than of Pigou's because it


    is simple.

    Criticism:-
    (i) Unrealistic Assumption:- CBA assumes that some of the factors like
    K₃T, Dand R tobe constant. But in real life all these factors are not
    constant. (i) Ignores Speculative Demand For Money:- CBA does not
    explain the Du comprehensively. According to this theory, demand for
    money is meant for transaction and precautionary motives alone. It
    ignores Dm for speculative motive.

    ii) Circular Reasoning:- According to CBA, on the one hand, price level
    (P) or value of money is determined by cash balance (k) but on the
    other hand, price level (P) or value of money determines cash balance
    (k). Thus the theory suffers from circular reasoning im as much as it
    asserts that value. of money determines cash balance and cash
    balance determines value of money. It fails to establish a precise
    relationship between the two.

    (iv) Incomplete Theory:- CBA is an incomplete theory as it gives


    importance to one factor, i.e., current income (R) in detce mining cash
    reserve (k). But in reality, cash reserves depend upon several factors
    Il., price level, monetary habits of people, etc.

    (V) Ignores The • Effect Of Rate Of Interest:- CBA does not accord any
    importance to changes is rate of interest. As a matter of fact, a change
    in the quantity of money first causes a change is rate of interest. A
    change is rate of interest causes a change in volume of investment. A
    change in volume of investment causes a change is cost of production
    and a change in cast of production causes a change in the price level.
    CBA ignoree this logical process of change.

    (vi) Ignores The Influence of Real Factors:- CBA asserte that a change
    in the value of money is due to change in the Day. But the value of
    money is also influenced by several other real factors like saving,
    investment, income, etc. This theory ignores the infle- -ence of these
    real factors.

    (vii.) Lacks Integration Between The Theory Of Value & The Theory of
    Money:- According to Don Pactinkin, CBA fails to integrate the theory
    of value (or relative prices) and the theory of money (or general price
    level). This theory has completely separated the theory of value from
    Theory of money In reality, both the theories are mutually inter-
    dependent.

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