Question

1. Explain the role of money according to the Cambridge approach. Specifically, explain the relationship between the quantity of money, the price level, and the level of output.

Answer 1

According to Cambridge cash-balance theory, the value of money depends upon the demand for money. But the demand for money arises not on account of transactions but on account of its being a store of value. 

To determine the money demand Cambrige economists used the equation:

$M$^d=k*P*Y

where k - a portion of the money supply will not be used for transactions and will be held for the convenience and security of having cash on hand;

P*Y - nominal income (the product of the price level and real income).