# Brief Notes on Keynes’ the Real Balance Quantity Equation

Dissatisfied with Pigou’s equation, Keynes formulated his own equation called “The Real Balance Quantity Equation” which is as under:

P = n/k

Where, n is the quantity of money in circulation,

p is the price of a consumption unit,

k refers to the real balance. It is measured as the amount of consumption units (viewed as a set of specified quantities of the people’s standard items of consumption) the community prefers to hold in the form of cash.

It is easy to see that if k is constant, a change in causes a proportional change in p.

To consider the bank deposits component of money supply, Keynes extended the equation as follows:

P = n/k + rk’

Where, r denotes cash reserve ratio, i.e., the proportion of cash reserves maintained by banks against their deposits.

k stands for the real balance held in the form of bank money.

Thus, if k, k’ and r remain unchanged, n and p will directly vary in the same proportion.

Keynes, however, does not regard that k and k’ are independent of n – the stock of money. Again, k and k’ may not be affected by small changes in the stock of money.

But they are bound to be affected by large changes in the stock of money. When k, k’ and r are influenced by n, there is no fully proportionate variation of p caused by changes in n.

In reality, p will change as per the changes in the ratio n/k’

Thus, Keynes’ approach is more rational than that of Pigou.

Keynes’ real balance equation, however, is not free from defects. In fact, Keynes himself had recognised certain defects in it, which he pointed out later, in his Treatise on Money, as discussed below:

1. In Keynes’ equation, P refers only to the price level of consumption standard value of money, in a narrow sense. In other words, P does not measure the purchasing power of money in a general sense.

2. The real balance equation disregards industrial and financial transactions; hence its application is limited.

3. When P measures only the price level of consumption units, the equation seems to suggest that people hold money only to secure consumption goods. But in reality, people hold money for a “vast multiplicity of business and personal purposes” and with a multiplicity of motives, such as transactionary, precautionary and speculative.