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Quantity theory of money
- 1. Quantity Theory of Money Economics
- 2. Money “Anythingisgenerallyacceptableasa means of exchange andthatatthe sametimeactsasameasure andasa store of value”. “MoneyiswhatMoneydoes”.
- 3. Quantity Theory of Money • QuantityTheoryof MoneywasfirstPropoundedin1588 byanItalianEconomist,Davanzati. • John Locke wasclearlyformulatedtheTheory (attempted to explaintheriseinpricesin Europe). • TheorywaselaboratedbyDavid Hume in1752. • Of Money(1752)–“Itis noneof the wheelsof trade:it isthe oil which renders themotionof thewheelsmoresmoothandeasy”
- 4. Quantity Theory of Money P = f (M) P - Price Level M - Money Supply f – Functional Relationship M M2 M4 P P2 P4 Price Level Quantity of Money • DirectrelationshipbetweentheQuantity of Money inaneconomy and thelevel of prices of goodsand servicessold. • The amountof moneyinaneconomydoubles,pricelevelsalsodouble, causinginflation(thepercentagerateatwhichthelevelof pricesisrising in aneconomy). y x
- 5. Irving Fisher’s Theory of quantity of money
- 6. Irving Fisher (1867 – 1947) “Purchasing Power of Money” - 1911 Quantityof Moneyincirculationincreases,thepricelevelalsoincreasesin direct proportionandtheValueof moneydecreasesandvice versa. Quantityof Moneyisreducedbyonehalf,thepricelevelwillalsobereducedby onehalfandthevalueof moneywillbe twice. M V+ MˈVˈ = P T M- Money Supply V - Velocityof Circulationof M(Numberof Transaction) P - Price Level Mˈ- Credit Money Vˈ- Velocityof Circulationof Mˈ (Numberof Transaction) T - Transactionperformed(Totalno.of G/S exchangedfor money)
- 7. M M2 P P2 P4 M M2 M4 1/P2 1/P4 1/P Price Level Value of Money Quantity of Money M4 Quantity of Money Fisher’s Quantity Theory of Money x x y y
- 8. Fisher’s Quantity Theory of Money Assumptions P isinactiveelement(PricelevelwillnotinfluencetheMoneysupply) V& Vˈ isassumedto be constant. Theproportionof Mˈ to M remainsconstant.. T alsoremainsconstant. Criticisms Equation of Exchange does not explain the cyclical behaviour of Prices and Production. UnrealisticassumptionsuchasV,T etc.,areconstant. PriceleveldependsuponmanyotherfactorslikeConsumptionhabits,CentralBank Policy etc., EquationtreedMoneyasMediumof Exchangeonlyandrequiredfor Transaction purpose only.
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