01/05/2013

What is quantity theory?

QUANTITY THEORY

Supply of money
Demand of Money

Ahmad Cahyo Nugroho

Crude Quantity Theory

The value of money varies inversely with the
amount of money in circulation
When linked to the price of good and
services?

Crude Quantity Theory

M = k.P or P = M/k
When:
M
k
P

= Amount of Money
= Constant
= Price

01/05/2013

Crude Quantity Theory

This theory is very simple, and doesn't
describe the actual state of condition

Quantity theory by Irving Fisher

There are 3 factors that influence the value of
money:
Volume of Money
Velocity of Money
Volume of Trade

Quantity theory by Irving Fisher

If E is Expenditure or total amount o
E=MxV
(1)
E=TxP
(2)
MxV=TxP
(1 + 2)

E
M
V
P
T

=
=
=
=
=

Expenditure
money supply
speed of circulation of the money (M)
price level
quantity of goods and services produced

Quantity theory by Irving Fisher

What influence Money Supply:
Monetary Basis
Creation of Money
Reserve Requirements

What Influence velocity of money:

Payment Frequency
Spending Habit
Saving Habit
Investment Habit

What Influence Volume of Trade:

Quality and Quantity on Production Factor

Employment
Business Specialization and Organization

01/05/2013

Quantity theory by Irving Fisher

M , V and T remains sl l P ?
V , M and T remains sl l P ?
T, M and V remains sl l P ?

Quantity theory by Irving Fisher

M , V and T remains sl l P
V , M and T remains sl l P
T, M and V remains sl l P

Quantity theory by Irving Fisher

Cash Balance Theory

The assumptions underlying Fisher's theory is:

price level is always really passive?

Is it true that the comparison between M with M1 is
always stable?
The fact is, that assumption is not always true. The
price level is not passive but enough to play an
important role in determining the volume of trade (T)
Initiated by D.H. Robertson is basically an improvement
of the Fisher Equation. If Fisher multiplying M with V so
that the same as P multiplied by T, then the cash
balance theory approach PT multiplying by a factor "k"
equal to M.

The price level (P) is a passive factor in the

equation.
Fisher assumed that all sources have full
employment economy.
Among the factors that affect V is the payment
habits of the people considered to be sufficiently
stable or permanent.
Comparison between the number of M with the
M1 is considered stable or permanent.

01/05/2013

Cash Balance Theory

M = k x P.T
Factor "k" shows how part of the total annual public
expenditure needs to be saved in cash
The background and theoretical assumptions used by the
cash balance theory remains the same as the assumptions
used in the quantity theory of Irving Fisher
Fisher theory Money movement
Cash Balance Dormant Money

Income Velocity Approach

M=k.P.Y
M = Amount of money
k = Part of the GNP in the form of cash, so
this essentially equal to 1 / V
P = Price
Y = Real GNP

Income Velocity Approach

This theory was pioneered by Marshall of
Cambridge University, so often called Marshall
Equation
Marshall connects the quantity of money in
the Gross National Product
Marshall did not emphasize on the velocity of
money in a period, but on the part of the GNP
which is manifested in cash

Income Velocity Approach

Marshall did not use the volume of goods traded (T) as
a means of measuring the amount of output, but with
a "Y" is to show the Real GNP
In Quantity Theory by Irving Fisher and Cash Balance
Theory assumed that:
T is considered fixed because it is always considered to be
in a state of full employment
Velocity is also considered to be relatively fixed, unless
there is a significant change in habits

As a result of these two assumptions is that the money

supply only affect currency prices proportionately and
can not affect real output