Page 109 - DECO402_Macro Economics

Macroeconomic Theory

Notes (Here M: Quantity of currency or money in circulation; V: Velocity of quantity of currency or money
in circulation; M′: Quantity of bank money or credit money; V′: Velocity of credit money; Y: Total
quantity of goods or services which are exchanged through the medium of money. It shows the actual
GDP. P: Price level)
From the above equation it is known that by multiplying the quantity of money (M + M′) with its
velocity (V + V′), net supply of money in a definite period may be known and by multiplying the
quantity of goods and services in a definite period of time (Y) with the price level (P), demand for
money may be known.

As per Fisher, in a definite time period, M′, V, V′ and Y are constant, hence a direct relation
establishes between quantity of money and price level. In other words, on an increase in quantity
of money (M) there is also an increase in price level (P) and value of money decreases in the same
  1
proportion   .
  P
Assume, M = `. 100, V = 8
M′ = `. 200 V′ = 4
Y = 400
+
×
+
MV M V′′ 100 8 200 4 800 800
×
+
P = = =
Y 400 400
1600
= = 4
400
 1  1
And value of money   = Rs. =
 P  4
 The Underlying Classical Assumption
Inverse relation between quantity of money and price level or a one to one relation between quantity
of money and value of money is an important conclusion of classical theory and it is based on the
assumption that there is only one job of money, which is medium of exchange.
Especially it is assumed that apart from being a medium of exchange, there in no other job of money,
like store of value. If for once, this assumption is removed, (and definitely it must be removed
because this assumption is opposed to actual life situation) then assertion of statistical relation
between one for one supply of money and price level will crumple. It has been mentioned in the
next section of the unit.
As per Fisher, proportion between credit money (M′) and money in circulation (M) remains constant.
It means that if money in circulation (M) doubles, credit money (M ) will also be doubled. Hence,
1
M = ` 200, V = 8
M′ = ` 400, V′ = 4
Y = 400
×+
×
200 8 400 4
P =
400
3200
= = ` 8
400
1 1
And value of money =
4 8

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