The value of money means purchasing power of money. When we
say that value of money is increasing, it means that a unit of money can buy
more goods and services. Fall in value of money means that less quantity of
goods and services can be bought with a given amount. Value of money has
inverse relation with the general price level. A rise in general price level
would thus indicate a fall in value of money and vice versa.
Money acts as a measuring rod of value for all other goods
and services, it is essential that we should know how the value of money itself
is determined. What are the factors, which bring about changes in general price
level. There are various theories to explain how value of money is determined
economic activity. Thus decreasing rate of demand is brings deflation in the
economic system. One of those is the
quantity theory of money.
1.
Quantity theory of money:
According to this theory. The value
of money is depended upon the quantity of money is circulation any change in
the total quantity of money in change in country effect prices and the changes
is prices of goods effect the value of money stats that changes in general
price level occur due to changes in the quantity of money in circulation. So
that an increase in quantity of money. Causes a rise in price level. A
contraction in quantity of money will lead to a fall in general price level. Taussing
define the theory as, “double the quantity of money and other things being
equal, prices will be twice as high as before, and the value of money is half.
Half the quantity of money and other thing being equal, prices will be half of
what they were before and the value of money double”.
Equation of exchange:
Fisher has expressed the quantity theory of money in a simple
equation which is called equation exchange.
P
= M(V) + M’(V’)
T
P = price M =
circulation of money
V = velocity of money M’ = circulation
of bank money
V’ = velocity of bank money T = transactions
P = M(V) +M’(V’) If
T M
= 10
i.
P = 10(5) + 10(5) M’
= 10
10 V
= 5
P = 50 +
50 V’
= 5
10 T
= 10
P = 100
10
P = 10
ii.
P = 20(5) + 20(5) If
10 M
= 20
P = 100 + 100 M’
= 20
10 V
= 5
P = 200 V’
= 5
10 T
= 10
P = 20
2.
Assumption of full employment is wrong:
J.M. keneys has raised an objective that the
assumption of full employment is a clear phenomenon in the economy and the
theory not clear.
3.
Rate of interest ignored:
In the quantity theory by fisher, the
influence of the interest rate on money supply and the level of prices had been
completely ignored. The fact is that an increase or decrease in money supply
has an important effect on the rate of interest. An increase of money supply
leads to declaim in the rate of interest and vice versa.
4.
Ignored other factors of price level:
There are many determines other than M, V and
T which have an important application on the price level. The factors such as
income, expense, compultion, population etc had been ignored from the theory.
5.
Various variables and transaction are not independent:
The various variable and transactions equation are not
independent. As assumed in the theory, the fact is that they vary much
influenced each other. Examples when money supply (M) increases, the velocity
of money (V) also goes u. take another case. Fisher assumes price (P) is a
passive factor and ha not effect on trade/transaction (T). In actual practice
when price level rises. It increase profits and promotes trade.
P = 5(5) +
5(5) If
10 M
= 5
P = 25 + 25
M’
= 5
10 V
= 5
P = 50 V’
= 5
10 T
= 10
P = 5
Assumptions of the theory:
1.
Full employment:
The theory is based on the assumption of full
employment in economy.
2.
Transaction(T) and velocity (V) are constant:
The
theory assumers that the volume of trade is short run remains constant. So in
the case of velocity of money which remains unaffected.
3.
Constant relation
between M and M’:
Fisher assumes constant relationship between
the currency money (m) and bank money.
4.
Price level (P):
Price level is a passive factor of increase
the equation. (P) is effective by other factors in equation examples P.M.M’.V.V
out it doesn’t affect them.
Criticism of the theory:
The
quantity theory is subject through the following criticisms,
1.
Unrealistic assumption
The theory is based on unrealistic assumptions. In the
theory (P) is considered as an in active factors. T, M, M’, V, V’ are constant
in short run all these assumptions are covered under other thing remaining same.
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