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CA Foundation · Business Economics · Money Market

In the Cambridge cash balance approach, the demand for money is given by Md = k × P × Y, where k is the proportion of money income people wish to hold as cash. If nominal national income (PY) is ₹50,00,000 crore and the money supply in equilibrium is ₹10,00,000 crore, what are the value of k and the implied income velocity of money?

k equals 0.2 and velocity equals 5. In equilibrium money demand equals money supply, so k = 10,00,000 divided by 50,00,000 = 0.2. Velocity is the reciprocal of k, which is 1/0.2 = 5, meaning each rupee circulates five times in a year.

  1. Ak = 0.2 and velocity = 5Correct
  2. Bk = 5 and velocity = 0.2
  3. Ck = 0.2 and velocity = 0.2
  4. Dk = 0.5 and velocity = 2

Explanation

In equilibrium Md = Ms, so k = 10,00,000/50,00,000 = 0.2. Velocity is the reciprocal of k, so V = 1/0.2 = 5. Check: 10,00,000 × 5 = 50,00,000. The option with k = 5 inverts the ratio and takes the wrong base.

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