THE VALUE OF MONEY

The term 'value of money' means the purchasing power of money. It refers to the general purchasing power of money * There is an inverse relationship between the level of prices and the value of money Vm = 1 p A rise or fall in the general price level does not mean that the price of each and every commodity has risen or fallen in the same proportion. ather general price level denotes the central tendency of a group of prices.
THE QUANTITY THEORY OF MONEY

The !uantity theory of money e"plains the determination of money at any one time and the variation of this value over periods of time in terms of changes in the !uantity of money. The theory has got two approaches: 1. The Transaction Approach or #isher's Version $. The %ash &alance Approach or %ambridge Version. 'owever( we shall confine our discussion on the most widely discussed version i.e. #isher)s Transaction version only.

The Transaction Approach or Fisher s Version

This version e"plains that( other things remaining unchanged( the changes in money supply bring about a direct and proportionate change in the price level and hence( an inversely proportionate change in the value of money. Ass!"ptions: 1* The +rice ,evel -+* is a +assive #actor $* Total volume of transactions -T* remains unchanged. .* The velocity of circulation of money -V* also remains constant /* The ban0 money is a function of lawful money. The E#!ation o$ e%change: 1V = +T or( + = 1V 2here( T 1' represents the !uantity of money in circulation 'V' stands for the velocity of money in circulation '+' is the general price level or average price per unit of 'T' 'T' represents the aggregate volume of transaction for which money payments are made. &The E#!ation states that + is directly related to 1V and inversely related to T. The E%ten'e' For" o$ the e#!ation o$ E%change is : MV(M V ) *T or+ * ) MV(M V T It is because in the modern economy money includes not only notes and coins but ban0's demand deposits and credit money also. A ,RITI,AL EVALUATION OF THE TRAN-A,TION VER-ION OF THE QUANTITY THEORY

The 3uantity Theory of 1oney has been thoroughly critici4ed by the 5eynesian economists. The shortcomings of the theory as depicted by the critics are discussed below6 ./ The assumption that V(V' and T and the ratio between 1 and 1' are constant is highly unrealistic In fact T changes with changes in technology( '7V etc. T may be constant only in case of full employment which is not attainable. The inflation in 8ermany in 19$. was due to increase in V. &ecause everybody tried to spend a rapidly depreciating 1ar0 as !uic0ly as possible. It is not proved that there is a proportional relationship between 1 and 1'. :uring 8reat :epression of the ;<A ban0 deposit fell by .=> while currency outside ban0 rose by .? >. 0/ The assumption that T and V are independent of + and 1 is also not true. In fact all elements in the e!uation is inter related. .* The e!uation 1V=+T does not show how and why in fact money supply does changes and how an increase and decrease in 1 reacts upon +. /* There is inconsistency li0e 1 refers to a point of time( whereas V refers to the turnover of money during a period of time. =* The assumption of #ull @mployment is unrealistic in the sense that due to huge unemployed resources in the economy every increase in 1 would lead to an increase in real income and output. A* The theory does not throw light on national income. T is the e"penditure on both final and intermediate transactions but national income measures aggregate e"penditure on final products only. B* The theory is static in nature as it considers other things remaining unchanged. It fact society is dynamic. C* It fails to e"plain the cyclical movements of prices and production. The price level can not held stable simply by ma0ing appropriate adDustment in money supply. -@". 8reat :epression of the ;<A* 9* +rice level does not entirely depend on factors included in the e!uation. :ue to human wants( diversification industry( trade price . 1?* The theory overemphasi4es the role of money supply. +opuation price level 11* T represents commodity transactions only. %ommodity transaction is part of whole transactions as there are financial( commercial and industrial transactions. 1$* The theory relates to money in circulation. &ut people do 0eep some money as balance for future . The Inco"e Theory o$ *rices According to 3uantity theory 6 %hanges in the !uantity of money causes a change in the aggregate demand for goods and services. According to Income theory 6 %hanges in the demand for goods and services are results of changes in income rather than money supply. @"ample6 If volume of e"penditure of a community goes up the income of the community also goes up As a result further e"pansion of e"penditures ta0e place. %onse!uently( the economy will e"pand and ultimately( production( employment( trade as well as price level will rise. Epposite will happen if the community reduces its volume of e"penditure. A rise in money income increases demand for goods of the people. Fow if real income is could be raised by high productivity then there will be not much effect on the price level. &ut if there is bottlenec0s preventing output from increasing in proportion to the increased demand( then the rise in money income would cause prices to rise.

Hansen s E#!ation o$ Inco"e Theory + = 7GE 2here + means the price level( 7 denotes the level of money income and E is the level of output or real income. This e!uation implies that if money income rises more rapidly than output or real income price will tend to rise. And if real income -E* increases more rapidly than money income -7*( the price level -+* may fall. Thus we see that the flow of income in relation to the flow of goods and services -real income* determines the price level and not the changes in the !uantity of money. 1EYNE- - ,ONTRI2UTION : -AVIN3- AN4 INVE-TMENT A**ROA,H According to 5eynes aggregate e"penditure which constitutes the income Hflow( consists of e"penditure on consumption goods and on capital goods. *Thus( 7 = %II i.e. Income I %onsumption I Investment -+rivate and +ublic* *The aggregate investment is the difference between aggregate income and aggregate consumption I = Y-C. * The same true in case of aggregate savings -<* i.e. < = 7H % * <ince 7 H % is common in both the cases it follows that I = S i.e. Investment = <avings. The parado" that savings is e!ual to investment can be e"plained if we ta0e savings and investment as aggregates. All individuals in an economy can not save more than their investment. Ta0ing investment as a constant when an individual attempts to save more( he spends less on consumption. %onse!uently( income of the others( depending on consumption sales( goes down. 2hen their incomes decline( there is corresponding decrease in their savings. H their consumption being constant. Thus an increase in individual's savings is e"actly offset by decrease in other)s savings. Accor'ing to 1eynes: 5hen saving is e!ual to investment( the economy is in e!uilibrium. This is true below full employment. Fow if investment e"ceeds savings -IJ<* as a conse!uence of credit creation( both income and e"penditure will rise( raising at the same time the level of employment and prices. 2hen income rises due to e"cess of investment over savings( savings -being the function of income* also start rising. This reduces the gap between savings and investment. Thus new savingsHinvestment e!uilibrium is restored at a higher level of income and higher price level. Alternatively if savingsJ investment then opposite direction will be followed. <ince( the variation in income cause fluctuations in the value of money ( the value of money or price level will tend to be stable if savings and investment are in e!uilibrium. If savings e"ceeds investment then value of money rises and vice versa.