In the classical system money serves just as a medium of exchange; it is used to carry out the transactions and it is neutral in its impact on the economy, it cannot influence the real variables like income, output and employment. However, the economy can influence the monetary variables like price level and monetary wages. Thus according to the classical economists, price level is the function of money supply. For this they have presented quantity theory of money. It is as double the quantity of money, double will be the level of prices. Thus any changes in supply of money will bring a proportional changes in the price level. It is represented by the equation of exchange: MV=PY.
Where M= supply of money, V= velocity or the number of times it turns over per time in the purchase of final output Y, P= price level of output Y. MV= PY is an identity so also written in the form MV= PY. This identity states that the quantity of money multiplied by the number of times each unit of money on the average is spent for final output in any time period multiplied by the price level of those goods and services PY. As Y represents GNP, p is the price level of the goods and services produced Y, and the V is the number of times the money supply is used to purchase goods whose value is PY then GNP identify may be explained as GNP= C+I+G= MV= PY.
Where M= supply of money, V= velocity or the number of times it turns over per time in the purchase of final output Y, P= price level of output Y. MV= PY is an identity so also written in the form MV= PY. This identity states that the quantity of money multiplied by the number of times each unit of money on the average is spent for final output in any time period multiplied by the price level of those goods and services PY. As Y represents GNP, p is the price level of the goods and services produced Y, and the V is the number of times the money supply is used to purchase goods whose value is PY then GNP identify may be explained as GNP= C+I+G= MV= PY.
