ANY MONETARY ECONOMICS THEORY

Any Monetary Economics Theory

Any Monetary Economics Theory

Introduction

Quantity theory of money states that the supply of money has a direct proportional relationship with the level of prices. For instance, according to this theory if the circulation of currency increases, it would lead to a proportional increase in the prices of goods and services in the economy. Hence, the theory proposes that there exists a positive relationship between fluctuations in the supply of money and the prices of goods and services in the long run.

Quantity Theory of money

There are some equations that have been derived which describe the relationship between the supply of money and the relative effect on the prices of goods and services in the economy (p.65). The equations for the quantity theory of money are as follows:

Equation of Exchange

The quantity theory of money is based upon the following relationship in its latest form:

M. VT = ? (pi . qi) = pTq

In this equation, M represents the total amount of money that is in average circulation in an economy during a specific period of time, usually a year. VT represents the transactions or as better known in the theory, as the velocity of money. This is the frequency on average on all transactions upon which one unit of money is spent (p.70). This velocity would be representing the availability of the variables of economics, financial institutions and the choices made by consumers on decisions which saw their swiftness in turning over their money. The pi and qi represents i-th transaction's prices and quantities. P is the column vector of the pi and T in the superscript represents the transpose operator. The q element is the column vector of qi. This equation has been further simplified, which is more commonly used in the mainstream economics (p.74). The simplified equation is as follows:

M . VT = PT . T

In this simplified version, PT represents the level of prices that are related with the economic transactions during the particular period of time. T represents the index of the real value of the aggregate transactions. The above mentioned equations had certain complications in terms of the relative data that is usually unavailable for transactions of every kind. Economists have now further simplified the equation for ease of operations to:

M . V = P . Q

In this equation, V represents the velocity of money in terms of the final expenditures of the consumers. Q represents the index of the real value of the consumers' final expenditures (Mehra, Y. P., 1989, Pp.262-266). To further comprehend the equation, it needs to be applied. For instance, M would represent the currency including the deposits in savings and checking accounts of the public. Q would be the actual production, which in terms of macroeconomic equilibrium would be the real expenditure which would be corresponding to the price level P and the nominal production value would be represented by P . Q (p.75).

However, the equation does not imply that a fluctuation in the supply of money would ...