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CMA Foundation · Fundamentals of Business Economics and Management · Money and Banking

Under the Cambridge cash balance approach, the demand for money is expressed as Md = kPY. If k is 0.25, the price level is 2 and real income Y is 800 units, what is the demand for money?

The demand for money is 400. Under the Cambridge approach people hold a fraction k of nominal income as cash. Nominal income is price level 2 times real income 800, giving 1,600, and one quarter of that is 400. Ignoring k would wrongly give 1,600.

  1. A400Correct
  2. B200
  3. C1,600
  4. D3,200

Explanation

Md = k x P x Y = 0.25 x 2 x 800 = 400. Check: nominal income is 1,600, and a quarter of it is held as cash, giving 400. The figure 1,600 ignores k.

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