it deals quantity theory of money.

1. N.DHINAKARAN
ASSISTANT PROFESSOR OF ECONOMICS
VIVEKANANDA COLLEGE
TIRUVEDAKAM WEST
MADURAI
Course Title : Money and Banking
Course Code: 01CT31 ( Unit – II)

2. UNIT-II:
Monetary Theories: Quantity Theory of Money–
Fisher’s Quantity Theory of Money –
 Cambridge Equation: Pigou, Marshall,
Robertson and Keynes.

3. The Quantity Theory of Money
 The quantity theory of money a very old theory .it was first propounded in 1588 by an Italian
economist Davanzatti.
 Latter the classical economists explained the value of money interms of the quantity theory of
money.
 Classical Economists like David Ricardo, David Hume and J.S.Mill not accepted theory but
also sought to introduce improvements and refinements in this theory.
 The credit for popularizing this theory in recent years rightly belongs to the well known
American economist Irving Fisher who in his book The Purchasing Power of Money
published in 1911.
 The quantity theory of money aims at explained the factors that determine the general price
level in a country .
 Whenever price level increases the value of money decreases and when price level decreases
the value of money increases. Why does the value of money change? Or why does the price
level change?. The quantity theory of money attempts to answer to this question.

4. The Quantity theory of Money has Two Approaches
1. The Cash Transaction Approach ( Fisher Version )
2. The Cash – Balance Approach (Cambridge Version)
1. The Cash – Transaction Approach ( Fisher Version)
Introduction.
The cash transaction version of the of the quantity theory of money was presented by
Irving Fisher in his famous book The Purchasing Power of Money in 1911.
According to Fisher money has a medium of exchange of buying and selling of goods.
There are several forces that determines the value of money and general price level.
The general price level in a community is influenced by the following factors.
A) The volume of Trade or Transaction
B)The Quantity of Money
C) Velocity of Money

5. Fisher Equation
An American economist , Irving Fisher ,expressed the relationship between the
quantity of money and the price level in the form of an equation , which is called
‘Equation of Exchange”. This is PT= MV
According to Fisher if the quantity of Money is doubled, other things being
equal, the price level will also be doubled, but the value of money halved. If the
quantity of money will halved , the price level will be halved but the value of
money is will be doubled.
For example if the supply of money is raised by 50 percent the price
level will also rise by 50 percent the value of money will fall by 50 percent. In the
opposite direction a fall in the supply of money by 50 percent will followed by a
fall in the price level by 50 percent but rise the value of money by 50 percent.
 The value of money increases or decreases by same percentage as the value
decreases or increases in the quantity of money

6. M – represents the total quantity of money in circulation
V- indicates the velocity of circulation
P – represents the price level
T – represents the total volume of transaction
 This MV (the left hand side of the equation of exchange ) represents total supply of money in the economy.
PT ( the right – hand side of the equation of exchange) represents the money value of all goods and services
bought during a given period of time.
MV ( Supply of Money ) = PT ( Demand for Money)
The above equation is referred to as Cash Transactions Equation. It also expressed as follows
P =MV
T
MV= PT

7. MV+M’V’ = PT
OR
P= MV+M’V’
T
M – the quantity of money in circulation
V – the velocity of circulation of money
M’ – the volume of bank or credit money
V’ – the velocity of circulation of bank or credit money
Fisher quantity theory of money can be explained with help of following
example. Suppose M= Rs 2000, M’ = Rs 1000, V= 3, V’ = 2 , T = 4000
P = (2000 X 3) + ( 1000 X 2)
4000
=Rs 2 per unit

9. Assumption in Fisher’s Equation of Exchange
The price level (P) is a passive variable
The total volume of transaction “T” is an independent but constant variable
in the short run.
The velocity of circulation of money ,V, is an independent element in the
equation and is constant in the short period.
Full Employment
The ratio M’/ M is constant
Short – Period Analysis

10. Criticisms of Fisher’s Equation of Exchange
The Quantity Theory of Money is based on unrealistic assumptions
The quantity Theory of money offers us a long – term analysis of
money
There is no direct and proportional relationship the quantity of money
and the price level.
The Quantity Theory is based on the wrong assumption of full
employment.
The quantity Theory ignores the rate of interest as determinant of the
price level.
It is difficult to measure the velocity of circulation of money

11. The Cash – Balance Approach (Cambridge Version)
Introduction:
The cash balance approach was propounded by Cambridge economists like Marshal,
Pigou, Robertson and J.M. Keynes.
According to Cambridge economist money acts as store of value is a function of money.
The value of money according to cash balance approach depends upon the demand for
and supply of money.
According to the Cambridge economist , that demand for money refers to that total
quantity of money which is held by private individuals, commercial firms, and the
government their day – to – day transactions.
An increase in the demand for money means smaller demand for goods and services,
because the people can have larger cash balances by only cutting down their expenditure
on goods and services.
Consequently , the price level fall, but the value of money will rise.
A fall in the demand for money means as larger demand for goods and services on the
part of the people. Consequently, the price level will rise but the value of money will fall.
The Cambridge economists have attempted to express the relationship between the
supply of and the demand for money by formulating cash balance equation known as “
Cambridge Equations”.

12. Marshall’s Equation
• The Marshall equation is expressed as
M = KPY
• Where
• M is the quantity of money
• Y is the aggregate real income of the community
• P is Purchasing Power of money
• K represents the fraction of the real income which the public desires to hold in the form of
money.
• The value of money in terms of this equation is dividing the public desire to hold out of
the total income KY by the total supply of money M.
P= KY
M
Here P represents the purchasing of money.
According to Marshall’s equation, the value of money is influenced not only by
changes in M, but also by changes in K.

13. Pigou’s Equation
• Prof. Pigou further developed the cash balance approach equation given below.
P = KR
M
In this equation
P represents the purchasing power of money or value of money
R indicates the aggregate real income
K represents that proportion of real income ( R) held by public in the form of cash
balance
M denotes the total money stock or total cash held by a community

14. The above equation of cash – balance is extended by Pigou to include the bank
money components in the demand for money
P = KR { C+h(1-C) }
M
In this equation
C is the proportion of money which the public keeps in the from of legal tender
h represents the proportion of cash reserve to deposits held by the banks
( 1 – C) implies that proportion of total money which is held by the people in the
form of banks deposits.
According to the above equation , P varies directly with K or R and
inversely with M. This further implies that the price level varies inversely with K or
R and directly with M.

15. Assuming K and R as constants, an increase in the quantity of money will lead
to inversely proportionate changes in the value of money

16. Robertson’s Equation
• Prof. Robertson’s equation is as follows
P = M
KT
In this equation ,
P = Price level
M= Supply of Money
T= Total amount of goods and services to be bought during one year
K = that proportion of T which the people desire to hold in the from of cash

17. According to Robertson’s equation, P changes directly as M, and inversely
as K or T.
There appears to be a close similarity between fisher’s equation and
Robertson’s equation. Fisher’s transaction equation is P = MV
T
Robertson’s cash balance equation is P = M
KT
In the two equation ,P, M and T more or less convey the same meaning. And
V is reciprocal of K, i.e., V = 1
K .
Fisher’s equation consider money as a medium of exchange, while
Robertson’s equation money as a store of value.

18. Keynes’ Equation
• Keynes equation is expressed as:
n = pk (or) p = n / k
• Where
 n is the total supply of money
 p is the general price level of consumption goods
 k is the total quantity of consumption units the people decide to keep in the form of cash,
n = p (k + rk') or p = n/(k + rk‘
In this equation
n represents total money supply
p indicates price level of consumer goods
k denotes peoples' desire to hold money in hand (in terms of consumer goods) in the total
income of them
r represents the ratio of their banks cash reserves to their deposits
k' = community’s total money deposit in banks, in terms of consumers goods.

19. THANK YOU