Quantity Theory of Money
Economics

Money
“Anythingisgenerallyacceptableasa
means of exchange andthatatthe
sametimeactsasameasure andasa
store of value”.
“MoneyiswhatMoneydoes”.

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”

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

Irving Fisher’s Theory of
quantity of money

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)

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

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.

Thank - You