CA Foundation Economics Chapter 8

Chapter number 8 marks

What is Irving Fisher’s Equation of Exchange and its extended form including credit money?

• Basic form: $MV = PT$

• Extended form: $MV + M'V' = PT$

• $M$ & $M'$ = Currency & Credit money supply

• $V$ & $V'$ = Velocity of currency & credit

• $P$ = Price level;

$T$ = Volume of transactions

What are the primary assumptions regarding $V$ and $T$ in Fisher's Quantity Theory of Money in the short run?

• $V$ (velocity) is constant,

determined by payment habits.

• $T$ (transactions) is fixed due to full employment.

• Direct proportional relationship exists between $M$ and $P$.

• Inverse relationship exists between $M$ and

value of money ($1/P$)

What is the Cambridge Cash Balance equation and how is Cambridge '$k$' defined?

• Equation: $M_d = k \cdot PY$

• $PY$ = Nominal National Income

• $k$ = Proportion of nominal income held as cash

• Expresses money demand as a function of income/wealth.

What is the core conceptual difference between Fisher's Approach and the Cambridge Approach to demand for money?

Fisher emphasizes money strictly as a medium of exchange.

• Cambridge emphasizes money as a temporary store of value.

• Fisher focuses on supply/flow ($MV$).

• Cambridge focuses on demand/stock ($kPY$).

According to Keynes, what are the three motives for holding money?

• Transactions Motive: Day-to-day expenditure ($L_1(Y)$)

• Precautionary Motive: Unforeseen contingencies ($L_1(Y)$)

• Speculative Motive: Capital gains on bonds ($L_2(i)$)

• Mnemonic: TPS (Transactions, Precautionary, Speculative)

How does speculative demand for money react to changes in market interest rates?

• Inverse relationship: Interest rate $\uparrow \implies$ Speculative demand $\downarrow$ • High interest rates $\implies$ Bond prices low $\implies$ Buy bonds. • Low interest rates $\implies$ Bond prices high $\implies$ Hold cash. • Formula: $LR_s = f(i)$.