Page 111 - DECO402_Macro Economics

Macroeconomic Theory

Notes from Mohan from the same rupee. In this manner, in a specified period of time a note of
one rupee accomplished the transaction of exchange for four times, in order words, a note
of one rupee did the job of four rupees. Hence, the velocity of one rupee will be called four.
To know the velocity of money in a country, Gross National Product is divided by money
in circulation.

Gross National Product (GNP)
Velocity (V) =
Money in Circulation

In this manner, gross supply of money = MV + M′V′

2. Demand for Money

Money is demanded because it does the job of medium of exchange. Hence, on any given time, demand
for money depends on the exchange being done in the society. Quantity of exchange depends on two
things:
(i) Trade Transactions- Y: by trade transactions is meant, gross physical quantity of goods and
services sold in form of money through trade transactions, in a specified period of time. As
many times this object is sold in the specified period, it is counted in trade transaction.
(ii) (P) Price Level: Average price of each unit of ‘Y’, in a specified period is known as price level
(P). In detailed meaning, it is known as general price level.
Hence, Demand for money = Price Level (P) × Trade transactions (Y) (P’)

Price in Form of a Passive Parameter
Fisher’s opinion is that price (P) is an inactive parameter. Price is determined by the supply of money,
but it itself does not determine the value of production, income and employment of the economy,
nature of all these is to stabilise on the level of complete employment. That is why in Fisher’s equation,
there is no influence on parameter Y of the changes happening in parameter P.

Assumptions of Quantity theory of Money

Quantity theory of money is based on the following assumptions:
1. Constant velocity of currency (V) and velocity of bank money (V′): It is assumed that velocity
of currency (V) and velocity of bank money and credit money (V′) remain constant.
2. Generally, in the economy situation of full employment is found.
3. Constant trade transactions: Due to the situation of full employment Fisher’s assumption is
also that in a specified time, quantity of trade transactions (Y) i.e. quantity of goods, services
and securities remain constant.
4. Constant proportion between bank money (M) and currency (M′): This theory is based on
the assumption that changes in quantity of bank money (M′) happen in the proportion of
quantity of currency (M). When quantity of currency is extended, then there is an extension
in the bank money also in the same quantity. As opposed to this, when there is shrinkage in
currency, then there is proportionate shrinkage in bank money also because people withdraw
their bank deposits. As a result, there is a reduction on quantity of bank money.

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