Advantages and Disadvantages of the Cambridge Equation
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Advantages and Disadvantages of the Cambridge Equation

Advantages and disadvantages of the Cambridge Equation Advantages of the Cambridge Equation The Cambridge equation, which in fact was a later form of the Quantity Theory, sought to remove some of the shortcomings of the latter and took several steps on the way to the modern theory of money and prices.

Advantages and disadvantages of the Cambridge Equation

Advantages of the Cambridge Equation

The Cambridge equation, which in fact was a later form of the Quantity Theory, sought to remove some of the shortcomings of the latter and took several steps on the way to the modern theory of money and prices. The old theory did not provide any explanation of the velocity of circulation of money. Instead of explaining the frequency with which money changed hands, the Cambridge equation tried to explain why money rested (instead of moving) in people's hands. This was an important shift in emphasis. An attempt was now made to analyze the motives on account of which people wished to hold money.

Similarly, there was a switch away from the analysis of causes of changes in the supply of money to an analysis of the causes of changes in the demand for it.

Another important new element in the Cambridge version was that instead of being concerned with the total number of transactions, it was concerned with the level of income. It thus concentrated attention on a concept which occupies an important place in the whole of modern economic theory. The Cambridge equation went some way towards explaining both short and long run changes in the level of income.

Disadvantages of the Cambridge Equation

This theory did not satisfactorily separate price changes and changes in the level of output which are included in the changes in the level of money income.

Besides, the Cambridge version is an over-simplified explanation of the theory of money and prices. It ignored the speculative demand to hold money.

Thus, it lost sight of an important fact that the quantity of money may change without corresponding changes in the level of money income or that money income may change without corresponding changes in the quantity of money. Also, ignoring the speculative demand meant that the theories of interest were not linked with the theories of level of income through demand for money. This is an important omission.

Thus, the Cambridge version is an inadequate guide to the understanding of the mechanics of price changes. Its misleading simplicity obscured more than it revealed.

In the words of A.C.L. Day, "Although the Cambridge version of the Quantity Theory represented a big advance on the Fisher version, it is not in itself an adequate monetary theory. Its weakness is that it is too simple to deal adequately with the complexities of the economic system." Its weakness lies in this that it does not pay attention to the fact that effective demand for goods and services does not necessarily vary at all closely with the quantity of money. To understand variations in effective demand, we must analyze the excess of changes in expenditure. The second weakness is that it pays inadequate attention to the fact that the price level does not necessarily change in proportion which changes in effective demand.

 

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