ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

Quantity Theory of Money in Economics : A Brief Note

Updated on December 21, 2015
icv profile image

IRSHAD CV has been a student in Economics. Now he is doing Masters in Economics. He completed B.A. Economics from the University of Calicut.

Quantity theory of money is one of the important part of macro economics. Since money matters has more important. The theory has long age as money. Actually the initial feeds of the theory was introduced by dawan zatti an Italian economist in 1588. Later the theory was modified by different economists like Irvin fisher, ac pique and j.m Keynes till the 20th century. Any how, now Quantity theory of money has two versions

1 – cash transaction approach

2 – cash balance approach

Each of them are described briefly as below

1 – cash transaction approach

Cash transaction approach of quantity theory of money was developed by Professor: Irvin Fisher. He also introduced a equation to explain the theory. So, it is also known as Fisher’s equation of exchange. Simply the theory dealing with the relationship between supply of money and price level. In short, the theory states ‘ any changes in the supply of the money will be resulted in the same proportional change in the price level. Which means when quantity of the supply of money increases the price level also increase’. That is a positive relation between quantity of money supply and price level. Further the theory also states that ‘ any changes in the quantity of the supply of money will inversely affect the value of money’. Which means when the money supply increases the value of money will decrease. So there is a negative relationship between quantity of money supply and the value of money.

Equation of the theory by Professor: Irvin Fisher

To explain the theory, Professor: Irvin Fisher introduced a equation popularly known as the ‘equation of exchange’, the equation is algebraically showing below.


In the equation M = quantity of money

V = velocity of money

P = general price level

T = total volume of transaction

Velocity of money : - velocity of money refers to the total number of times the money is circulated in an economy or the number of times, the money is changes from hands to hands

In the left hand side of the equation (MV), is the supply of money and the right hand side of the equation (PT), is the demand for money.

To explain the theory we assume that, V and T in the equation are constant. Then quantity of money (M) is vary directly with price level (P). Any way in summary the theory suggest two major facts occurring in an economy due to changes in the quantity of money supply. They are

A – when money supply increases the price level also in increases ( will doubled)

B – when money supply increases the value of money will decrease ( will become half )

Diagrammatic representation of the theory

The transaction approach of the theory can be represented as showing in the graph below.

In figure 1, the total quantity of output is represented on the ‘x’ axis and the price level on the ‘y’ axis. And consider the quantity of output is constant at the level of ‘Q’. And MS1 is the initial supply curve of money M1 is the quantity of supply of money. Where the price level is P1. then suppose, an increase in the supply of money from M1 to M2, then the price level also increased by P2 from P1. It showing a direct relationship between quantity of money supply and the price level.

2 – Cash balance approach

This is the second version of the quantity theory of money. Actually the major contribution to the development of the cash balance approach labelled in the name of famous economist A.C. Pique. The cash balance approach is explained with the help of the Cambridge equation. So, the cash balance approach is also called as Cambridge version. The significance of the Cambridge version is it is not only considered on the supply of money but also focuses on the demand for money.

The Cambridge equation derived from the same equation of exchange, that is MV=PT. Then the equation is solving for M, then we will get

M = PT/V

The equation can be rewrite as given below.

M = 1/V * PT

For simplicity we can take ‘k’ in the place of 1/V. So, the equation become


In the equation M = money supply

P = price level

T = total volume of transaction

K= the demand for money the people want to held in hand

Since, K is equal to 1/V the velocity of money and the demand for money as a store of value is inversely related. In simple words the people demand money to held in hand is inversely related with the velocity of money.


Quantity theory of money is one of the most important theory in Economics dealing with the relationship between supply of money and price level, value of money etc. the theory stating that there is a direct and proportionate relation can be see between supply of money and price level, and a indirect relationship between supply of money and the value of money.

In short, now, quantity theory of money has two versions, namely cash transaction approach and the cash balance approach. The cash transaction approach emphasizes on the supply of money while the cash balance approach highlights the demand for money.

Keynesian View on Quantity Theory of Money

Keynes reformulated the quantity theory of money introduced by classical economists which was based on the assumption of full employment. According to quantity theory of money money supply and price level are vary in a direct way in a certain proportion. But later, J.M Keynes reformulated the same quantity theory of money by adding the theory of interest.

Keynesian's view was based on many assumptions as showing below.

a) the factors of productions are perfectly elastic and there exist unemployment in the economy.

b) All unemployed factors of production are homogenous in nature, that is one factor can use instead of other factor.

c) And all these factors are based on the Constant Return to Scale. When a certain percentage of factor input increased, it will give same proportionate increase in the output.

Based on this assumptions, Keynes argue that, the increasing of money supply resulted in the reduction of interest. Once the interest rate is declined, people invest their money (capital formation) instead of depositing with bank. Gradually the increasing of investment reduce the unemployment and increase the income. Since the factors of production are based on Constant Return to Scale, there is no possibility to increase the price of the commodity. And there is no any chance for raising the price proportionate to raising money supply. In short, after the full employment is attained (all resources are utilized) the increasing money supply varies directly with price level.


    0 of 8192 characters used
    Post Comment
    • icv profile imageAUTHOR


      5 years ago

      Yes. The traditional view rewrote by keynes. Then again the controvercy existing

    • JohnfrmCleveland profile image


      5 years ago from Cleveland, OH

      The quantity theory of money is one of the most damaging economic misconceptions I can think of offhand. Monetarist thinking currently dominates our government, even though they are dead wrong. Prof. John Harvey takes apart MV=PT in this article:

      In reality, savings (including trade deficits) drain money from the economy all the time, but few economic schools of thought even bother to factor this in. And new dollars (in the right hands) lead to new and increased production, not higher prices necessarily.


    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at:

    Show Details
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the or domains, for performance and efficiency reasons. (Privacy Policy)
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)
    ClickscoThis is a data management platform studying reader behavior (Privacy Policy)