Fisher's Quantity theory of Money

1. Quantity Theory of Money

2. Contents
Introduction
01
Demand for Money
02
Theories of Money
03
Conclusion
04

3. Introduction

4. Quantity Theory of Money
Attempts to explain the changes in
the value of money (or the general
price level) by the changes in the
quantity of money.
The value of money varies
inversely with the quantity of money
and the price level varies directly
with the quantity of money.

5.  The demand for money explains us what
urges people to wish a definite amount of
money. Money is needed to manage
transactions and the value of transactions
will certainly decide, the money people
would want to keep.
 The larger is the quantum of transactions to
be made, the bigger is the quantity of
money demanded. Since the quantum of
transactions to be made relies upon earning,
it should be lucid that a rise in income will
lead to a rise in demand for money
Demand for Money
 When people stockpile their savings in the form of money rather
than keeping it in a bank which fetches them interest, how much
money people stockpile also relies upon the rate of interest.
 Particularly, when interest rates rise, people become less focused
on stockpiling money since holding money leads to holding less of
interest-earning deposits, thus less interest received. Hence, at
more interest rates, money demanded decreases

6. The Demand Curve for Money.
The demand curve
for money shows the quantity
of money demanded at each
interest rate.
Its downward slope
expresses the negative
relationship between the
quantity of money demanded
and the interest rate.
Demand for Money

7. Factors Which Increase the Demand for Money
A rise in the demand for
consumer spending.
A rise in uncertainty about
the future and future
opportunities.
A rise in the belief of the
future value of the
currency.
A reduction in the interest rate.
A rise in transaction costs to
buy and sell stocks and bonds.
A rise in the demand for a
currency by central banks
(both domestic and foreign).
A rise in inflation causes a
rise in the nominal money
demand but real money
demand stays constant.
A rise in the demand for a country's
goods abroad.
A rise in the demand for domestic
investment by foreigners.

8. Other Determinants of Demand for Money
An increase in real GDP
increases incomes
throughout the economy.
The demand for money in
the economy is therefore
likely to be greater when
real GDP is greater.
The higher the price level,
the more money is required
to purchase a given
quantity of goods and
services. All other things
unchanged, the higher the
price level, the greater the
demand for money.
 Expectations about future price levels also
affect the demand for money. The expectation
of a higher price level means that people
expect the money they are holding to fall in
value. Given that expectation, they are likely to
hold less of it in anticipation of a jump in prices.
 Preferences also play a role in determining the
demand for money. Some people place a high
value on having a considerable amount of
money on hand.
The demand for money will
increase as it becomes
more expensive to transfer
between money and
nonmoney accounts. The
demand for money will fall if
transfer costs decline. In
recent years, transfer costs
have fallen, leading to a
decrease in money demand.

9. Demand for Money
An Increase in Money Demand. An increase in real GDP, the
price level, or transfer costs, for example, will increase the
quantity of money demanded at any interest rate r,
increasing the demand for money from D1 to D2. The
quantity of money demanded at interest rate r rises from M
to M′. The reverse of any such events would reduce the
quantity of money demanded at every interest rate, shifting
the demand curve to the left.

10. Types of Demand for Money
Transaction Demand
Money needed to buy goods – this is related to income
Precautionary Demand
Money needed for financial emergencies.
Asset motive/Speculative Demand
when people wish to hold money rather than buy assets/bonds/risky
investment.

11. Functions of Money
M
SS
M
Measure of Value.
Medium of Exchange

12. Quantity Theory of Money and Prices
Hume
There exists a casual
relationship between
money supply and price
level.
Locke
The value of money or the
general price level was
exclusively determined by
the quantity of money
Sophisticated Version
There exists a functional
relationship between price level
and quantity of money
Mercantilists
Quantity of money is a
determinant of the level of
prices
Crude Version
There exists a strict
relationship between
changes in the price level
and the quantity of money.
P = kM P = f(M) P = f(M)

13. Fisher's Transactions Approach /
Fisher's Equation of Exchange
The Transactions version of Quantity theory of Money was provided by the American Economist Irving Fisher in his book:
“The Purchasing Power of Money” (1911)
According to Fisher, “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”
Fisher's Quantity theory of Money is explained with the help of
his equation of exchange.

14. Fisher's Equation of Exchange
The Supply of money consists of the quantity of money in existence (M), multiplied by the number of times this money change hands
i.e., velocity of money (V). Thus MV refers to the total volume of money in circulation during a period of time. Since money is only to
be used for transaction purposes, total supply of money also forms the total value of money expenditures in all transactions in the
economy during a period of time.
MV
Supply of Money
Money is demanded not for hoarding, but for transaction purposes. The demand for money is equal to the total market value of all
goods and services transacted. It is obtained by multiplying total amount of things (T) by average price level (P)
PT
Demand for Money

15. Fisher's Equation of Exchange
Fisher's equation of exchange represents
equality between the supply of money or the total
value of money expenditures in all transactions
and the demand for money or the total value of
all items transacted.
Thus Supply of Money = Demand for Money
i.e., MV = PT (or)
P = MV/T
i.e Total value of money expenditures in all
transactions = Total value of all items
transacted
Where M is the Quantity of Money
V is the transaction of Velocity
P is the Price level
T is the total goods and services
transacted
Identity Equation
Equation of exchange is an identity equation. i.e., MV is identically equal to PT.
The equation states that what is spent for purchases (MV) and what is received
for sale (PT) are always equal
Fisher used the equation of exchange to develop the Classical quantity theory of
money, i.e., casual realtionship between the money supply and the price level
In the long run, under full-employment conditions, total output (T) does not
change and the transactions velocity of money (V) is stable.
Fisher concludes that the level of prices varies directly with the quantity of
money in circulation provided the velocity of circulation of money and the
volume of trade which is obliged to perform are not changed. Thus V and T
being unchanged, changes in money cause direct and proportional changes in
the price level.

16. Extension of Equation of Exchange
MV + M'V' = PT (or)
P = MV+M'V'
T
Irving Fisher extended the equation of exchange
so as to include demand (bank) deposits (M') and
their velocity, (V') in the total supply of money.
Thus the equation of exchange becomes:

17. The level of general prices (P) depends on five definite factors”
Volume of Money in circulation
Its Velocity of Circulation
Volume of Bank Deposits
Its Velocity of Circulation
Volume of Trade
Thus the transactions approach to the quantity theory of money
maintains that, other things remaining the same, i.e., if V, M', V' and T
remain unchanged, there exists a direct and proportional relationship
between M and P.

18. Example
Suppose M = Rs.1000, M' = Rs.500, V= 3, V' = 2, T= 4000 goods.
P = MV + M'V' / T
P = (1000x3) + (500x2) / 4000
P = Re.1 per good
Value of Money (1/P) = 1
If the supply of money is doubled
P = (2000x3) + (1000x2)/4000
P = Rs.2 per good
Value of Money (1/P) = 1/2
If the supply of money is halved, then
P = (500x3)+(250x2)/4000 = Rs.1/2 per good
Value of Money = (1/P) = 2

19. Assumptions
Price level is a passive
factor
Constant relation between
M and M'
Constant volume of trade or
transactions
Money is a medium of
exchange
Constant Velocity of Money
Long Period

20. Criticisms
Interdependence of Variables.
Static theory and technically inconsistent.
Fails to explain trade cycles
Fails to integrate Monetary theory with price theory.
Unrealistic assumption of long period
Unrealistic assumption of full employment
Ignores other determinants of price level
Money as a store of value ignored
One-sided and Redundant theory

21. Thank you
Dr.Saradha A
Assistant Professor
Department of Economics
Ethiraj College for Women