Please help me with this...Quantity theory of Money in Economics??

Question

What is the quantity theory of money? and also what is the significant of this theory??

Answer 1

In economics, the quantity theory of money is a theory emphasizing the positive relationship of overall prices or the nominal value of expenditures to the quantity of money.

The quantity theory emphasizes the following relationship of the nominal value of expenditures PQ and the price level P to the quantity of money M:

               +

    (1) PQ=f(M)

         +

    (2) P=g(M)

The plus signs indicate that a change in the money supply is hypothesized to change nominal expenditures and the price level in the same direction (for other variables held constant).

Milton Friedman described the empirical regularity of substantial changes in the quantity of money and in the level of prices as perhaps the most-evidenced economic phenomenon on record. Empirical studies have found relations consistent with the models above and with causation running from money to prices. The short-run relation of a change in the money supply in the past has been relatively more associated with a change in real output Q than the price level P in (1) but with much variation in the precision, timing, and size of the relation. For the long-run, there has been stronger support for (1) and (2) and no systematic association of Q and M.

Principles

The theory above is based on the following hypotheses:

   1. The source of inflation is fundamentally derived from the growth rate of the money supply.

   2. The supply of money is exogenous.

   3. The demand for money, as reflected in its velocity is a stable function of nominal income, interest rates, and so forth.

   4. The mechanism for injecting money into the economy is not that important in the long run.

   5. The real interest rate is determined by non-monetary factors: (productivity of capital, time preference).

Decline of money-supply targetting

An application of the quantity-theory approach aimed at removing monetary policy as a source of macroeconomic instability was to target a constant, low growth rate of the money supply. Still, practical identification of the relevant money supply, including measurement, was always somewhat controversial and difficult. As financial intermediation grew in complexity and sophistication in the 1980s and 1990s, it became more so. As a result, some central banks, including the U.S. Federal Reserve, which had targeted the money supply, reverted to targeting interest rates. But monetary aggregates remain a leading economic indicator. with "some evidence that the linkages between money and economic activity are robust even at relatively short-run frequencies."

Answer 2

I define economics as chemistry of wealth. Quantity Theory of Money is one of the very few foolproof theories of economics that are firmly based on this universal Law: Law of Conservation. I define Quantity Theory on lines of Law of Conservation:

When wealth in the form of money is changed to wealth in the form of goods and services, value of wealth in the form of money equals wealth in the form of goods and services and that wealth is neither lost nor is it created.

Now, assume that goods and services are the wants that an economic entity wants to possess or acquire and assume that money is means needed for fulfilment of wants, this quantity theory encircles entire economics. Unfortunately no one has viewed this theory from larger perspective.

In simple words,

Value or quantity of money = Value of goods + services.

If money supply increases prices rise and if goods or services increase, prices drop.

The letter V or velocity has no significance. One must remember that every time money is changed goods and services also undergo change. All changes of wealth are reversible and that is the reason we ought to have credit of like amount for every debit in bookkeeping.