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Explain The Quantity Theory Of Money?

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Muhammad Abdullah786 Profile
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.
Nouman Umar Profile
Nouman Umar answered
The quantity theory of money was first put forward by Davan Zat in 18th century. It was then taken up by John Locke at the end of this century. According to Irving Fisher and other classical economists, the function of money primarily is to serve as a medium of exchange. Money is demanded for its purchasing power and not for its own sake. As regards the value of money it entirely depends upon the quantity of money in circulation in the economy. Purchasing power of money states that the quantity of money is the prime determinant of its value and hence of its price level.

We can say in other words, that price level is a function of the quantity of money in circulation. The transaction version of the quantity theory states that the changes in money supply other things remaining the same, bring about a directly proportionate change in the price level. Other thin remaining unchanged as the quantity of money in circulation increases, the price level also increasing in direct proportion and value of money decreases. If the quantity of money is doubled the price level will also be double and the value of money will be one-half.

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