Answer to Question #95236 in Macroeconomics for komal

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).