1. Chapter 02
MONEY & BANKING
Instructor: Ms. SHAHZEEN SHAH

2.  The Value of Money is the Purchasing
Power.
 The real value of a unit of money at
a given time and place is the quantity
of goods and services of all kinds
that can be purchased with a unit of
money.
 The value of money varies inversely
with the general price level.

3.  Cash Transaction approach to the Quantity
theory of money was given by Irving
Fisher (American Economist) in his book
‘The Purchasing Power of Money’ (1911).
 The value of money (The purchasing
power) in a given period of time depends
upon the quantity of money in circulation
(Money Supply).
 Money Supply determines:
 the General Price Level

4.  Quantity theory of money is the theory
that suggests money supply has a
direct, proportional relationship with the
price level and an inverse relationship
with the value of money (Purchasing
Power).
 In Fisher’s words, ‚Other things remaining
unchanged, as the quantity of money in
circulation increases, the price level also
increases in direct proportion and the
value of money decreases and vice versa‛.
 For example, if the quantity of money in
circulation is doubled other things being
equal the general price level will be

5.  Supply of Money
• Quantity of Money (M.S.) in circulation ‘M’
• Velocity of Money in circulation ‘V’
• MV= the total volume of money in circulation during
a period of time.
 Demand for Money
• The Demand for money is for the exchange of
goods.

6.  P = MV + M1 V1 or PT= MV+ M1V1
T
Here,
P is the price Level
M is the quantity of money
V is the velocity of circulation of M
M1 is the volume of credit money
V1 is the velocity of circulation of M1
T is the total volume of goods and Trade

7. Economists frequently debate how changes in the
amount of money that circulates in a nation's economy
(the money supply) influence the prices of goods and
services exchanged in that economy (the price level) as
well as the total quantity of goods and services produced
in that economy, or the output. The quantity theory of
money (QTM) and the Cambridge cash-balance theory
are two of the most prominent approaches to
understanding this complicated subject.

8. QTM, transaction approach, argues that changes in the
money supply directly influence the price level. As the
money supply increases, the value of each dollar (or
whichever kind of currency a nation uses) declines, and
therefore it takes correspondingly more dollars to buy
any given good or service. Consequently, an increase in
the money supply will cause prices to rise. Implicit in this
assertion is that money is only valued to meet people's
demand to conduct transactions -- for example, people
use money merely to meet their "transactions demand."

9. The cash-balance theory adopts a more nuanced understanding of
people's psychological relationship with money. It assumes that
money serves important purposes in an economy other than
meeting the transactions demand.
First, people do not sell and buy items simultaneously.
Instead, they hold on to cash as a "store of value," acquiring
money one day to spend it another day.
Second, people frequently retain money just in case they might
need it in an emergency. This means that people also have a
"precautionary" motive to hold on to money.
The cash-balance theory, therefore, rejects the notion that a
smooth relationship necessarily exists between money and
prices, with people automatically spending more money as the
supply increases. Moreover, fluctuations in the demand for
money might actually influence output and, hence, the
economy's real size.

10. Both QTM cash transaction and the cash-balance theory
accept that, in the long run, the money supply and price
level rise and fall together without changing output.
Unlike QTM cash transaction, however, the cash-
balance theory asserts that people often have strong
motivations to hold on to money. Hence, according to the
cash-balance theory, the money supply and price level --
and perhaps even output -- may diverge in the short run.